Charities - All change - not small change.

With Christmas just weeks away, Britain’s charities are gearing up for their seasonal fundraising drives. But this year charity FDs have more on their minds than banking the takings from armies of high-street tin rattlers. The whole voluntary sector is about to come under the close scrutiny of the Cabinet Office’s performance and innovation unit.

The review of the charities’ legal and regulatory framework, which was ordered by Tony Blair, could have come at a better time. Most of the 185,000 charities in England and Wales are already struggling with an unprecedented wave of change, while the unseemly spat over whether disgraced peer Lord Archer did or did not raise #57m for Kurdish relief work, has thrown an unwelcome spotlight on the financial management of charities.

Luke FitzHerbert, a leading figure at the Directory of Social Change, an independent body set up to help voluntary and community organisations, argues that the Charity Commission has not been a vigorous enough regulator.

“The monitoring of charity annual reports has not been adequate. In business accounts, you have the reality of a bottom line. In charities, there is no equivalent, so the quality of the narrative report and the detail of the accounts is more important,” he says.

FitzHerbert thinks many charities, perhaps because their accountants are conditioned by commercial practice, confine themselves to a ritual minimum. “We believe that a substantial proportion of charities’ annual reports are drafted by auditors, because we see the same phrases and formulae repeated over and over again,” he says. But he admits that the quality of annual reports varies dramatically, even among the top hundred charities.

Most charities would welcome a review which produced simpler legal and tax rules. But some are worried the government may use the review as an excuse to impose stricter controls. Three years ago, it launched a compact setting out the principles of its relationship with the voluntary sector.

This emphasised that the voluntary sector’s independence was “central” to its partnership with government.

Despite this, there is concern about the degree to which government is using charities to deliver programmes such as Sure Start and New Deal.

“We are developing a range of charities which are effectively government sub-contractors,” says FitzHerbert. “If you specialise in this, you risk losing one of the main values of a voluntary organisation – which is actually being voluntary.”

Last year, Britain’s charities raised #5.76bn, the highest level in real terms since 1993, according to the National Council for Voluntary Organisations.

Yet if they are to persuade the public to dig deeper, they will need to show more clearly that they are making a difference with the money they spend – and that may be their most difficult task yet, especially since management issues, such as developing best practice and recruiting quality staff are increasingly on FDs’ agendas at large charities.

Meanwhile, small charities are concerned about whether they can continue to go it alone in a world which increasingly favours size. There have already been some charity mergers and wise heads in the sector suggest that there will be be many more to come.

JOHN GRAHAM – FINANCE DIRECTOR, NSPCC

Like other large charities – its revenue will be around #90m this year – the NSPCC is raising more and more of its money in partnerships with companies. But commercial organisations are more concerned about how their money is spent than the individual donor popping #1 into a collecting tin. It’s not surprising, then, that John Graham believes the biggest financial issue he faces is accountability. “As FD, I’ve had an historic stewardship role to make sure that the money is spent wisely for the cause to which it has been donated. Increasingly, partnership donors are wanting to know what impact we’ve made with the money. We are moving towards outcome measurement alongside financial measurement,” he says.

Graham sees this requirement changing the fundamentals of how the NSPCC operates. “We have to look at the decision-making point of where money is spent. We have to get away from the local authority style of mentality – I have a budget and will spend up to it – and look more at the options for spending. People have to be aware that, if they are spending money, they must be accountable for the benefits that accrue from it,” he says.

Other key issues are transparency and accounting for the charity’s campaigning work. “Last year, we published a note to the accounts which showed how much we spent on campaigning. We are reinforcing that this year with more information about what our aim is in campaigning,” Graham says.

He would like to see the Cabinet Office review of charities improve the framework for mergers. “There is no clear process for a charity coming to an end. In the commercial sector, you have a process for how a merger or acquisition can go ahead, even if both parties are not in agreement. In the charity sector, there isn’t such a mechanism,” he says.

Graham believes charities would benefit from further consolidation. “We see that particularly with the government giving to children’s charities.

I think it would almost like a single point of contact,” he says. But government funding for charity work also raises the question of independence.

The NSPCC receives around 15% of its funding from local or central government for programmes such as Sure Start, the good parenting initiative. Graham points out that one other children’s charity receives as much as 80% of funding from official sources. “While I am generally in favour of government funding, I think we need to be careful that we don’t compromise our independence,” he says. “Traditionally, charities have been in areas where they may be putting across views which, perhaps, the government of the day is not in accord with.”

AILEEN McLEISH – DIRECTOR OF FINANCE, HISTORIC ROYAL PALACES

For Eileen McLeish, the foot-and-mouth outbreak can’t end soon enough. The disease which has ravaged the countryside has also hit the tourism and takings are down. With 90% of the Historic Royal Palaces’ annual #40m revenue coming from visitors, things are looking bleak this year. Even numbers at the Tower of London, the UK’s top heritage attraction, which pulls in 2.3m visitors in a normal year, are down 8%. “There are fewer Americans and those we have are cost-conscious,” she says.

The Historic Royal Palaces – which include Hampton Court, Kensington Palace state apartments and Queen Charlotte’s cottage in Kew Gardens – became a charity three years ago. It was previously a government agency and is still a non-departmental public body.

“If you are a government-funded body, people are loathe to donate money to you,” says McLeish, explaining the rationale behind the change in status.

“The government accounting regime – cash accounting – didn’t really lend itself to an organisation where the majority of our costs were covered by variable income,” she says. Apart from that, about a third of the organisation’s cost-base is major projects – often building conservation – which created a lumpy cash-flow that didn’t fit inside a government machine that thrives on predictability.

McLeish wants to develop new sources of revenue. She enviously cites the fact that the National Trust has 2.5m members. “We have a handful of season-ticket holders, but we haven’t really engaged in long-term relationships with people who come and visit with us,” she says. Building these could help smooth out the charity’s swings in trading income.

McLeish would like the Cabinet Office review to tackle the complexity of the legal and regulatory framework charities work with. “At the moment, we have to maintain two separate organisations – a trading company and a charity. I understand the rationale, but the complexity adds overheads.

It is a burden that falls on the finance function. If there could be a way to rationalise the legal framework, I think it would deliver a huge bonus for charities.”

McLeish is currently exploring ways to buy in outside purchasing expertise.

“We’re looking at having somebody on a retainer who, for example, could come in two days a week.”

The complex legal and tax structure surrounding charities can make it hard to attract the right staff. McLeish believes charities could tackle this problem by making more use of shared services. “If you can’t get income growth, you can make savings through consolidation and sharing overheads,” she argues. Back-office functions such as accounting and payroll are obvious candidates.

Overall, McLeish believes charities need to work towards best practice to cut overheads. “We should be using more of our resources for our primary purposes,” she says.

JAMES DAVIDSON – DIRECTOR OF FINANCE & ADMINISTRATION, CANCER RESEARCH CAMPAIGN

James Davidson has the prospect of a merger with the Imperial Cancer Research Fund on his mind. The two charities are currently conducting due diligence and staff consultation with a view to bringing the separate organisations together, possibly later this year. The new combined charity would dominate the remaining research cancer charities.

Davidson sees the merger as part of an essential consolidation process.

There are currently more than 800 cancer charities focusing either on finding a cure or on caring for cancer sufferers. While small may be beautiful in the caring end of the market, Davidson believes that size will be increasingly important for research. “You have to be able to work with big building blocks of science to derive benefit – and that means money,” he says.

The #107m-revenue Cancer Research Fund has already merged with World Cancer, a Bradford-based charity, and the North of England Cancer Research Fund. If the merger with Imperial goes ahead, as seems likely, the two could form an umbrella organisation under which everybody who wants to carry out specific cancer projects could operate.

For Davidson, charity mergers build more business-like, as opposed to charity-like, organisations, where work is carried out more efficiently.

That is important, he says, because more large charities want to operate internationally, and they won’t receive funding unless they are operating to the highest standards.

Donors are always concerned about administration costs. “It’s almost the first question I’m asked when I go to supporters’ meetings,” says Davidson. “We quote the costs as a ratio of income – in our case less than a penny in the pound. You would be hard-pressed to find a business that could operate at that level.”

But he admits that in the drive for professionalism, these costs may have to go up before they can come down. “We have to invest in new systems to derive benefits,” he says. And there are also salary and employment implications if charities are to attract good quality staff. “About three years ago, we were losing staff, such as accounts clerks, to local authorities, which are traditionally not high payers,” he says. “We refurbished the building and upped our salaries. In some cases, we just lifted them by a number of pounds, in others by a percentage. If you’re investing in a modern IT system and have to train staff to use it, it’s silly to lose them for an extra thousand.”

Looking to the future, Davidson sees the product of the charity’s research work contributing more than the roughly 5% of revenue at present. “In the course of our research, we discover new molecules which can be commercialised as drugs. We’ll take them to a certain stage and then license them to a pharmaceutical major. You can get millions back once that drug goes into production,” he says.