We explore the basics of full cost recovery and explain why charities need to secure funding for all costs involved in a project
Almost two decades ago, the National Audit Office (NAO) stated that the government recognised that no activity can be undertaken without its provider incurring central administrative costs. The government also established that if a provider is a charity, that charity should not be expected to subsidise these overhead costs from donations.
The NAO acknowledged that funders have both an obligation and an interest in meeting their fair share of overhead costs, as it helps to ensure providers can manage activities and finances properly. This principle of full cost recovery (FCR) applies to both procurement and grant-making.
FCR is the act of securing funding for all costs involved in a project, including direct costs and a proportionate share of overheads. FCR is crucial in the post-COVID-19 world. Competition for funding will be ever fiercer and the ongoing use of reserves – which may already have been drawn on throughout the pandemic – to fund overheads is not sustainable. At the same time, many charities face the prospect of doing more with less.
Here is a visual look at what FCR looks like:
Overheads typically include a broad range of costs. Some of these will be for the infrastructure of the charity such as offices and facilities, IT hardware and software, and possibly equipment and vehicles. If these didn’t exist, the charity might not be able to provide its services and so their recovery is important.
Similarly, charities might have paid finance, administrative, and management staff who fulfil vital roles but aren’t directly involved in projects. Their costs also need to be recovered.
Overhead costing is critical to costing and pricing services and activities. It enables charities to see what they should charge funders to break-even or generate a surplus. A charity that understands their cost base typically recovers a greater level of overheads in funding applications. Overhead costing also contributes to well-managed organisations and greater financial sustainability.
FCR is not a new concept. It has been discussed and promoted in the charity sector for many years. As Community Accounting explains: “It’s really just common sense. If an organisation doesn’t recover all its costs, it will go bust.”
But what has become more widely accepted is that those paying for activities, whether through grants or contract fees, ought to meet the true or full cost of delivering them.
There was a time when charities may have been tempted to not fully cost a grant application or contract bid for fear of pricing themselves out of being successful. This could be especially true with funders who would not typically care about how it was costed as long as it was delivered.
Overhead costs are not seen as exciting compared with directly funding a specific project addressing an area of extreme need. And they can sometimes be perceived as wasteful.
FCR is sensible for all charities. There is now far more awareness from grant-makers of the importance of ensuring that charities recover overheads. Indeed, some grant programmes are focused exclusively on funding overhead costs. But it isn’t always easy to get funders to recognise that they should pay.
Even if you can establish the principle of FCR with a funder, actually calculating a fair and appropriate amount to be apportioned to different projects can be a challenge.
Charities need to put in place processes for overhead costing and recovery when making grant applications. There are some good examples of what needs to be considered online, such as our step-by-step guide: How to apply full cost recovery for grant applications.
While calculating overall overhead costs may be relatively straightforward, apportioning them across multiple projects can be tricky. It requires a solid finance and administration system to calculate, track, and allocate costs.
Digital technology can assist in establishing processes and methods by which to do this. Dedicated accounting software helps charities track costs in real time, and then allocate overhead costs to different projects based on an assessment of fair apportionment. You will need to establish the parameters within which you allocate those costs, but the technology will make it far easier than manual processes to keep on top of things.
Importantly, using digital can help control and reduce overhead costs in the first place. While grant-makers will still require transparency of overhead costs, charities who have used digital processes to become leaner and more agile will be in a better position to attract funding.
Overhead cost recovery and planning isn’t just about fairness or financial efficiency and acumen. It is also about helping charities become better managed.
Charity Finance Group published guidance as long ago as 2007 titled “Know your cost, know your charity”. Being able to explain overheads and cost models in a transparent way can help facilitate better conversations with all funders, including grant-makers. This in turn will increase the percentage of successful bids.
In the long-term, charities who properly cost their work can build sounder infrastructure and ensure more robust governance. And, importantly, they can develop greater sustainability through a deeper understanding of the finances underpinning the organisation and the basis upon which strategic decisions are made.
Knowing your charity through cost and recovery planning will ultimately enhance your ability to meet your objectives and be even more effective.
Find more charity finance resources at the Sage Non-profit Success Hub.