The overhead myth and more …As a nonprofit leader, you likely spend a fair amount of time keeping track of income, setting up budgets for programs, and supervising fundraising initiatives. This isn't your whole financial picture, though. Without focused analysis, certain costs might slip through the cracks. Left undetected, these costs can take a serious bite out of your budget.
Enter cost analysis.
Cost analysis provides a clear picture of the financial demand each of your programs places on the organization as a whole, allowing you to make truly informed financial decisions. The result? Maximum impact at minimum cost.
Who needs it?
Let's say your nonprofit administers one program in a single location and has only a few employees. You're likely incurring few indirect costs and little overhead. In this case, cost analysis may provide only limited data. If your organization is more complex — administering more than one program or working out of more than one location, for example — cost analysis is likely to provide missing pieces of your organization's total financial story.
What's the impact of indirect program costs?
Cost analysis calculates both direct and indirect program costs. Often, direct costs are easier to see, estimate and budget — while indirect costs can be hidden or more challenging to get a handle on.
Imagine you receive funds to expand a program, so you add two or three additional staff members to that program's existing team. You account for the additional salaries in your statement of functional expenses, but what about the additional burden of hiring and training those new hires? This additional HR cost is an indirect cost.
As described by The Bridgespan Group, indirect costs typically include:
- General administration and management expenses (such as management staff salaries and benefits)
- Infrastructure costs (such as rent and utilities, transportation, equipment depreciation and technical licenses)
- Marketing costs, advocacy expenses and other costs incurred for the general benefit of your organization's programs
How should indirect costs be allocated?
A true-cost analysis allocates indirect costs to the various programs that actually incur them. It requires you to figure out, for example, what percentage of your HR budget each program makes up. The cost analysis can then reveal whether one or another of your programs is taking up a disproportionate amount of funds.
Another example might be site rental. Imagine you administer a single program at various sites. Each of those sites might have different rent or utility fees. Your cost analysis should determine, then, whether the higher rent at a particular site makes financial sense for your organization.
Just because something is expensive doesn't mean that it must be cut, of course. Instead, cost analysis provides a realistic picture of each program's efficiency and impact.
What information do you need to get started?
Whether your cost analysis is a DIY project or you're handing it over to an accountant or other financial specialist, you'll need to compile some basic information to get started.
Select the most recent time period for which you have complete data, such as the previous fiscal year. Then, gather:
- Program-specific costs
- Indirect costs (overhead)
- List of employees, including job descriptions, salaries and an estimated allocation of time by program
- Allocations of infrastructure usage, such as facilities, equipment, computers, paid software licenses and so on
Once you've gathered the relevant data, you can compare program to program — or year to year — to understand where your cash goes the furthest. It seems like a lot of work, we know. But it's worth it.
How should the results of cost analysis be used?
Cost analysis provides a comprehensive account of the total cost of all programs and locations as well as a targeted, specific analysis differentiated by program or location. Armed with this information, you can:
- Identify key areas of cost savings
- Target fundraising initiatives to the real costs of programs
- Negotiate with vendors and service providers with an eye to true programming costs
- Offer goods and services at prices that reflect true production costs
- Present realistic costs when applying for grants
- Evaluate the impact of providing certain services or programs on the financial health of other services
The Bridgespan Group: Nonprofit cost analysis toolkit by Marta Garcia Abadia and Johnny Lin (2009)