Charities are facing ongoing financial pressures that are no longer occasional; they are a permanent challenge. Cost inflation, funding uncertainty and rising demand are combining in a way that forces trustees to confront difficult trade-offs between financial sustainability and mission delivery. In that context, the question is no longer whether deficits will arise, but when are they acceptable and how do you distinguish between a managed position from one that is beginning to slip?
When we’re discussing these situations with trustees, the distinction usually comes down to intent, oversight and transparency.
Reserves Policies Under Strain
Many reserves policies were written in more stable times and are now being tested in ways that were not fully anticipated. Targets expressed as a fixed number of months’ expenditure can quickly become detached from reality when costs escalate, and income becomes less predictable.
In several recent audits, we’ve seen charities continue reporting against reserve targets that were set three or four years ago, even though rising costs have made them unrealistic in the short term. That in itself is not the issue; the greater concern is when there is limited evidence that trustees have revisited and challenged those assumptions.
The important shift is one from compliance with a policy to one of understanding the purpose of reserves in current conditions. For some charities, that purpose may now be to absorb short-term volatility or to allow continued service delivery through a difficult period, even if that means operating below the stated target for a time.
Auditors will generally not take issue with reserves being drawn down; indeed, that is often what they are there for. However, we do look for a clear narrative: why the reserves are being used, how this aligns with the charity’s strategy, and what the path looks like beyond the immediate pressure. A static disclosure alongside a deteriorating position tends to raise more concern than the drawdown itself.
Strategic Use of Reserves vs Financial Red Flags
A deficit, in isolation, is not a sign of financial weakness. In many well run charities, it is a deliberate and appropriate outcome of strategic decision-making. Trustees often focus on the year-end reserve figure. That’s understandable, but it can be misleading. A charity with lower than forecast reserves and a credible recovery plan may be in a stronger position than one meeting its reserve target but facing declining unrestricted income.
For example, a charity might deliberately budget for a deficit while launching a new service, knowing that reserves will cover the temporary shortfall until grant funding is secured. In these cases, there is usually a clear line of sight back to forecasts, supported by credible assumptions and active oversight from trustees. Potentially even the use of funds designations to set out this use of funds as a very clear strategic decision.
The picture looks very different where deficits are recurring without a clear underlying plan. Here, reserves are effectively being used to subsidise an operating model that is not financially viable in its current form. Over time, this erodes flexibility and reduces the charity’s ability to respond to further shocks.
When looking from an auditors viewpoint, the warning signs are rarely about a single year’s result. They tend to emerge from the direction of travel. A single difficult year rarely concerns auditors. What attracts attention is a pattern of losses, forecasts that rely on best-case assumptions, and little evidence that trustees are responding. Weak or infrequent management information can compound this, making it harder for trustees to get ahead of the issue.
In practice, the distinction often comes back to control. Where trustees can clearly articulate why a deficit has arisen, how it fits within a broader plan, and what actions are being taken, it is usually seen as a managed position. Where that narrative is absent or inconsistent, the same financial outcome can begin to look like a red flag.
How Auditors View Going Concern in Stressed Charities
These issues come into sharper focus when considering going concern. For charities under financial strain, this is often the area that attracts the most scrutiny both from auditors and from readers of the accounts.
The assessment is forward-looking and centres on whether the charity has sufficient resources to continue operating for a period of at least twelve months from the point the accounts are approved. That inevitably brings forecasts into the spotlight: not just their headline position, but the assumptions sitting behind them.
In stressed charities, auditors will look closely at cash flow rather than accounting results, the timing and reliability of income and the degree of headroom available. Sensitivity analysis becomes particularly important, understanding how quickly the position changes if funding is delayed, costs increase further, or planned savings do not materialise.
Where there is pressure, it does not automatically follow that going concern is in question. Many charities operate for extended periods with tight margins and limited reserves. However, where uncertainty is significant, that needs to be clearly reflected in the disclosures. A well-explained material uncertainty, supported by robust analysis, is often more reassuring than an overly optimistic assessment that does not fully engage with the risks.
What tends to give auditors confidence, even in difficult circumstances, is evidence of active management, regular forecasting, documented assumptions, and timely action where the position begins to move. Conversely, concern increases where forecasting is underdeveloped or where plans rely heavily on income that is not yet secured.
Conclusion
Deficits are likely to remain part of the landscape for many charities in the near term. The issue is less about their existence and more about their nature.
The charities managing these pressures most effectively are not necessarily those avoiding deficits altogether. They are the ones that understand why the deficit exists, have a realistic plan for dealing with it, and regularly revisit that plan as circumstances change.
For trustees, the focus should be on maintaining clarity of intent and strong financial overview. For auditors, the role is to assess whether that clarity is evident in both the numbers and the narrative.
Most trustees understand that deficits can sometimes be necessary. What matters is demonstrating that they are part of a conscious strategy rather than the result of drift. In the current environment, that distinction has never been more important.
If you would like to discuss anything mentioned in this article, please contact our charities team here.
This material is for informational purposes only and should not be relied upon as professional advice.
