The charity sector in Scotland is facing an unprecedented funding battle at a time when their services are in greatest need. That was the rather depressing conclusion outlined in a recent 'state of the sector' survey published by the Scottish Council for Voluntary Organisations (SCVO) in November 2012.

Its survey of more than 400 charities operating in Scotland found funding remains the primary concern going forward while last year's predictions that services and headcount would be cut were proven to be accurate.

However, only 18 per cent of the charities surveyed had reduced in size in 2012, which was an improvement on 25 per cent having cut back in the previous year. The survey showed there was also a"significant" increase in collaboration with other organisations in an attempt to reduce costs.

The overwhelming concern for this year is how charities will manage to cope with a surge in demand for services when competition is growing for limited resources.

Falling income, which for many comes from the public purse, was mitigated to some degree through a reduction in staff numbers, cutting staff hours and through mergers with other charities.

According to Gavin McEwan, sharing resources will be a key feature going forward. He says:"Sharing resources is usually focused on backroom functions such as IT and human resources, but other charities are also beginning to look more fundamentally at how they deliver project work.

"For those projects seen as unsustainable for individual charities, a joint venture can be the preferred delivery method to maintain public benefit and achieve charitable aims in the face of reduced funding.

"Those charities whose project work is funded mainly or substantially by central or local government are the worst affected funding wise and moves towards the personalisation of care are having additional impacts on charities working, for example, with disabled people.

"The Scottish Law Commission has picked up charities moving towards joint working arrangements and published a consultation paper recently considering new statutory means in delivering joint ventures.

He adds:"While this was well intended, many practitioners question the need for an Act of Parliament to allow collaboration as most charities already have the ability to enter into contracts for joint working arrangements."

SCVO's rather depressing outlook for 2013 is largely summed up in its assessment that 80 per cent of government welfare reform cuts are still to come, and more than 60 per cent of charities said those cuts will directly affect their operations.

More worrying still, more than 80 per cent said the coming year will be financially worse than last year while demand for services is predicted to rise"significantly".

Just one per cent of the charities surveyed believe the financial situation will improve.

More than 60 per cent of Scotland's 24,000 registered charities generate income of £25,000 a year or less. In 2011 those charities overspent by £18.4m, equating to around £2,000 in overspend for each charity in the low income bracket, according to figures compiled by Third Sector magazine. The picture wasn't much brighter for the mid-sized charities with annual incomes of between £50,000 and £100,000 – they too recorded an overspend averaging £17,000 over 2011. And a third of larger charities, those with incomes of between £500,000 and £10m, also ran deficits over the same period.

SCVO has warned many charities will be unable to continue to subsidise their operations from dwindling reserves as demand for services continues to soar.

Gavin believes new policy which recently came into effect may provide charities with a valuable lifeline. He says:"Recent legal changes give charities the power to review restricted funds to possibly free up those funds to better charitable effect.

"Restricted funds usually come about through donations or legacies which are for a fixed purpose and a legally binding condition only to use the donation or legacy for the stated purpose. That presents real problems for charities and up until November 1, 2012, the only way to tackle this problem would have been to go through an expensive and time-consuming court process.

"The new rules mean charities can now apply directly to the Office of the Scottish Charity Regulator (OSCR) to have restrictions amended, relaxed or even removed."
The UK Government has devised a novel 'buy now pay later' scheme to try to tackle funding shortfalls in the third sector through a new model being piloted called the Social Outcomes Fund. Ministers hope the £20m fund – which was launched in November 2011 – will ultimately attract a further £60m inprivate investment into 'preventative spend' projects highlighted in the2011 Christie Report on the Future Delivery of Public Services.

That report suggests approximately 40 per cent of public sector spend goes on"failure spend", where the state has failed to intervene in a child's life before they become a burden on the state.

Cabinet Office minister Francis Maude said the aim of the Social Outcomes Fund was to spur growth in social impact bonds in order to move the cost of some public projects to investors who would reap a dividend if the project is successful. Details remain sketchy on how these investments are priced and how the government will measure their success in value terms.

"The new rules reduce the inheritance tax rate from 40 per cent to 36 per cent on parts of an estate left to otherwise-chargeable beneficiaries – family and friends – though not spouses or civil partners who already benefit from exemptions.

"But some incentives designed to promote giving will have a more limited effect. The Small Gift Aid Donations Scheme at bill stage at Westminster will allow some charities to claim additional tax relief on small donations, though a track record must be demonstrated in reclaiming Gift Aid.

"The maximum benefit under the rules as currently drafted is only £1,500 per year, so this level of tax relief will be a drop in the ocean for larger charities."