Mind the Gap - Cost recovery in charities


Mike Bath, Director 
Newbury Office Wilkins Kennedy

Feb. 12, 2020


An organisation needs to know what its overheads are in order to avoid running at a deficit. However, as Wilkins Kennedy Director Mike Bath discusses, research by the Centre for Charity Effectiveness at Cass Business School showed that only around 1 in 3 charities had a firm grasp of their overheads, were good at recovering them and at negotiating with funders to cover them. 

Without a full understanding of how overheads relate to different services and activities, it is easy for a gap to open up between the actual costs incurred and the amount raised, either by charges to service users or contract/grant bids: a gap that will need to be covered either by diluting unrestricted funds or by additional third-party fundraising.

When a charity looks at the cost of a project, it needs to look at what support and resources it needs from the rest of the organisation as well as the direct costs of the project itself. Adding these two cost types together gives the full cost of the project, and full cost recovery is when funders pay for the relevant proportion of support costs (i.e. the charity recovers the full cost from them). This is what charities should aim for but is often far from easy in practice.

If a charity cannot recover the full cost of a project from funders, it needs to decide if the project is still something that it wants to do. There are often very good reasons for taking on projects that aren’t fully funded, but this decision needs to be taken carefully, and with an eye to what else might be done with whatever levels of unrestricted funds will be needed to ‘top up’ the full project cost. Where a project or service is only partially funded then the level of top up required needs to be kept under constant review.

Effective cost recovery means that a charity has confidence in its:

  • Sustainability. Each product or service line covers all of the costs to deliver it, whether direct or indirect;
  • Conversations with funders. If there is a robust and transparent methodology for allocation of costs to projects it is easier to negotiate with funders for full cost recovery;
  • Efficiency. A charity that knows where all of its overhead costs go will be better able to decide which projects should be prioritised where there are competing demands, and to examine how funds can be used in the best way.
A cost recovery toolkit for charities

Mark Salway of Cass has recently released a cost recovery toolkit for charities, having worked in this area for many years, building on the framework put forward by the Association of Chief Executives of Voluntary Organisations as far back as 2004. The primary aims of the toolkit are:

  • To provide charities with a consistent and accessible framework to calculate full cost;
  • To take the pressure off unrestricted funds by giving charities an evidence-based approach to cost activities more effectively;
  • To ensure that any subsidies from general reserves are transparent and can be monitored and managed.

The toolkit starts by splitting a charity’s entire cost base into three distinct categories:

  • Direct costs. These are the easiest to identify and to allocate and include costs such as staff costs (including Employers’ NI and pension contributions), and any project-specific purchases such as travel or materials;
  • Direct support costs. These costs link directly to activities or services but are shared across an organisation. These might include property costs (rent, rates, service charges, utilities etc) where a building is shared between several teams, or regulatory costs such as CQC or safeguarding.  These costs need to be allocated on an empirical basis, perhaps by floorspace or by headcount depending upon the nature of the cost;
  • Indirect costs. These are costs which do not directly link to any service or activity, but without which the charity cannot function effectively. These costs typically include governance costs such as the CEO’s salary, IT infrastructure & finance office costs.

Once the full costs have been identified the charity can make an informed decision on pricing. For grant awards, the amount of any grant is usually restricted to the full cost of providing the activity. In contrast, services delivered under contract may often allow an element of ‘profit’ and/or contingency. Contingency is particularly relevant if there is a significant risk that it may not be possible to deliver the contract in full due to factors which are outside of the charity’s hands: this might affect charities engaged in disaster relief or which operate in unstable regions. Pricing contingency into bids is common practice in commercial contracts and is an area that the charity sector should adopt more widely than it does currently.

Summary

The steps to full cost recovery can be summarised as:

  • Allocate a category for every cost within the charity: direct; direct support; indirect.
  • Apportion direct support & indirect costs on a structured and consistent basis across all the charity’s activities and services.
  • Calculate the full cost of each activity and service based upon direct + direct support + indirect.
  • Calculate any provision for surplus and/or risk contingency.
  • Consider how any shortfall (in funding achieved) might be covered.

The toolkit gives an example of a charity with a contract from a local authority worth £750,000 where the charity had originally calculated its overhead as being 7% of direct costs. Using the toolkit, the charity identified that its overhead was actually 20% - a typical figure for a charity and one which is far lower than for many commercial organisations. Armed with a robust and transparent analysis of its full cost position the charity was able to negotiate an additional £100,000 in funding.

What should you do next?

For further information on the areas raised in this Insight, or to discuss in more detail, please speak with your usual Wilkins Kennedy contact or a member of our specialist Not for Profit team.


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