How much will it cost? Program budgeting 101
Congratulations! The program officer at your favorite foundation has finally invited you to submit a proposal for the new program you would like to start.
You’re thrilled, but now comes the hard part: outlining a budget that will cover the true cost of operations. This calculation may not be as simple as it sounds. Some costs are obvious – program materials, salaries, location costs – but others are hidden. Here are some budgeting tips to consider while preparing your program proposal.
In finance and accounting, obvious costs are called direct costs and the hidden ones are called indirect costs. Direct costs are incurred specifically for the benefit of a particular program while indirect costs are incurred for the benefit of the organization as a whole. When figuring the cost of a new program, nonprofits must be careful not to overlook the less obvious but often very important indirect costs, potentially resulting in underfunding of the program.
The largest direct costs are typically the salary and benefits of the personnel delivering the program service. Non-personnel direct costs are often referred to as “other than personnel services” and typically include equipment, materials, supplies and transportation.
Classic indirect costs are rent, utilities, insurance and office expenses, such as internet access, photocopying and postage.
However, classification as a direct or indirect cost depends upon the context. For example, rent can be either a direct or indirect cost. The rent a social services organization pays for its administrative office is an indirect cost, but the rent the same organization pays for the site of its homeless shelter is a direct cost to the homeless shelter program. Similarly, snacks provided to children in an afterschool program are a direct cost, but the same snacks at the office holiday party are not.
Nonprofits tend to assume indirect costs will not be affected by the startup of a new program. This is not always true. For instance, a new program may require new staff. Do you have room in your office for the new staff or will you have to move to a bigger space? If you have to move, the increase in rent is an indirect cost of the new program. Often a new program requires a new type of insurance coverage. The new insurance is another indirect cost of that program. Before starting a new program, nonprofits should consider whether any of their indirect costs will change and identify funding sources for those indirect costs that will increase.
Also, nonprofits often overlook the cost of tracking outcomes. Many keep program data in Excel spreadsheets or hard copy forms. The cost of expanding either of these media to include a new program is negligible. However, the new program may add complexity that requires a new or upgraded software application. This is a significant cost that should be considered.
The decision to undertake a new program involves more than just the direct and indirect cost of operating the program. An important additional factor is the cost of supporting the program. This is especially important if the new program adds a significant number of staff to the organization. Can the existing infrastructure support the payroll, human resources, benefits and information technology needs of new staff or will the organization have to pay to expand its back-office capacity?
Support costs are also important if the new program adds a significant number of clients or vendors. Does the finance and accounting infrastructure have the capacity to promptly bill the new clients and pay the new vendors? If the new program has multiple funding sources, make sure your organization has the capacity to manage and report on them. Increasing organizational capacity to support a new program should be considered a cost of that program.
The greater the ratio of direct costs to total direct, indirect and supporting costs, the more feasible and the more sustainable the program. A program with 90 percent direct costs places only a minimal financial burden on a nonprofit, while a program with 50 percent direct costs will quickly drain the organization’s financial resources.
Unfortunately, there is no clear line between sustainable and unsustainable. The ideal ratio of direct to total costs for your new program depends on your sector. For example, organizations that require dedicated physical space, such as shelters, schools and museums, will have a higher ratio of indirect to total costs. Organizations that serve large numbers of clients, such as social service agencies, will have a higher ratio of supporting costs to total costs. The best source of guidance on an optimal cost structure for your new program is the umbrella group or organization that represents your sector.
Once you have totaled the direct, indirect and supporting costs of the new program, you have probably arrived at a number that is greater than the amount the foundation is willing to give. Furthermore, the foundation may be reluctant to fund indirect and supporting costs or may cap them.
You may choose to operate the new program at a loss if there is a strategic reason to do so. For example, if the strategic plan has set a goal of expansion to a new city, running a new program in that city at a loss may provide the benefit of introducing the organization to other donors who are willing to fund the program at a higher level. Of course, this is only possible if the nonprofit has the financial resources to absorb the loss. Remember that financial resources should include the ability to advance expenses if funds are available only on a reimbursement basis.
Other intangibles that should be considered include:
* Whether the program advances the organization’s mission and values.
* Whether the program fills a need which is unmet by your organization or any other nonprofit.
* Whether the program will have a dramatic impact on the organization’s constituents.
With a better understanding of direct costs, indirect costs, supporting costs, and intangibles, you gain the tools needed to make informed decisions about financing your new program and a strategy for preparing that very important foundation proposal.
Paul Konigstein is a senior consultant at Accounting Management Solutions, a division of CliftonLarsonAllen LLP , where he helps nonprofits master finance and accounting as an important part of their mission. Paul blogs for BoardAssist.org and leads webinars at 4Good.org and you can follow him on Twitter @PaulKonigstein. Paul holds an M.B.A. in finance from New York University and a B.S. in marketing from the University of Pennsylvania and has been assisting nonprofits for almost 25 years.