Full cost recovery

Full cost recovery is a means by which you recover rent and other indirect or overhead costs. It’s replacing the old system of funding for core costs and funding for projects. Through full cost recovery, each project pays a bit towards core costs like rent and the chief executive’s salary. The government is encouraging all public sector funders and the Big Lottery (see below) to allow for full cost recovery in funding applications. Many trusts are following suit.

Note that small grants of the type that small groups frequently apply for won’t require a full cost recovery.

There are a couple of points in this factsheet where the maths might seem complex. Take a quick break and come back to it. We have coloured some of the numbers so that the logic is easier to follow. Once you have completed your first full cost recovery it gets easier.

We plan to update this factsheet as an even simpler step-by-step guide. Follow/like us on Twitter and Facebook and/or subscribe to CASH eNEWS, and we’ll let you when it is published.

Riverside Elders Full Cost Recovery

Riverside Elders provides advocacy, minor home repairs and healthy eating/lifestyle advice to people aged over 60 living on an estate. The aim of the project is to enable people to live in their own homes rather than be taken into sheltered accommodation.

The staff time available to the charity is:

Manager 35 hours per week
Outreach worker 35 hours per week
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Total 70 hours per week

The manager spends half her time running the charity including fundraising and half her time running the advocacy project which is an output.

75% of staff time is allocated to sales or outputs. That is all the outreach worker’s time and half the manager’s time.

So 25% of rent, office supplies and similar costs (indirect costs) relate to the manager’s role in running the charity. The other 75% relates to the specific projects, the outreach projects and the advocacy project.

Riverside Elders Budget 2017 / 18

Manager salary, ENI, pension £30,000
Outreach worker salary, ENI, pension £25,000
Staff training £1,000
Staff travel £1,000
Materials (household repairs) £10,000
Rent rates heat light power £10,000
Office supplies £7,000
Audit & AGM £1,000
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£85,000

Indirect costs or overheads or core costs:

Manager’s time £15,000
Staff training £1,000
Staff travel £1,000
Rent & rates, heat & light £10,000
Office supplies £5,000
Independent exam & AGM £1,000
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£33,000

There is an argument that some of the travel or staff training could be allocated to specific projects, but we wanted to keep this example very simple.

We have put £2,000 of the office supplies into direct project costs to reflect that they produce their leaflets and to make funding bids look more attractive, ie. less indirect costs (overheads) more direct costs.

Full cost recovery excel image

The above graphic shows how the figures would appear in Microsoft Excel (or a similar spreadsheet package).

If you have more projects add extra rows D, E, etc

The salary is a straightforward proportion of the worker’s salary, national insurance and pension based on the amount of time the person spends on that project.

We have allocated the household repairs materials heading to project B and assumed that the materials for the other projects are £1,000 each and drawn from the office supplies heading.

We calculated above that the total indirect costs are £33,000.

There are various ways to allocate these costs to the different projects. For this example, we are going to use staff time as the “cost driver” by which indirect costs (core costs) are allocated.

We allocated the percentage of staff time to each project above.  We have one and a half posts allocated to projects and half a post to core activities like fundraising and administration.

To get a percentage multiple 1.5 posts by 100 to give 150. Now take the staff time used by the project and divide it by the 150. This gives a percentage by which you allocate the indirect or core costs to that project. So project uses half a post that is .5 of a post.  To get the percentage to work do 0.5*100 = 50. The word percentage means “as a fraction of 100”. We are putting the data into percentages to create uniformity.

If you are not familiar with the bracket in the equations below, you calculate the sum in the bracket first and then do the rest of the equation. So 50/150 = 1/3 or 33%.  1/3 of 33,000 is 11,000.

Project A uses 50/150 of the staff time spent on projects (this is the ratio for project A), so project A gets charged 33% of the indirect costs.

(You may need to think about this for a few minutes to understand it or come back to it again later).

(50/150) x 33,000 = 11,000

Project B uses 70/150 of the staff time spent on projects, so gets charged 70/150 of the indirect costs.

(70/150) x 33,000 = 15,400

Project C uses 30/150 of the staff time spent on projects so gets charged 30/150 of the indirect costs.

(30/150) x 33,000 = 6,600

See how the green and magenta coloured figures slot into the table above?

Unit costs

If the manager handles 80 advocacy cases a year, the cost per case is £27,000 / 80 = £337.50. The 27,000 comes from the top right cell of the table above.

If she spends 550 hours on advocacy work a year, the cost per hour is £27,000 / 550 = £49.10. You might price this at £50 or £49.50 per hour to provide for contingency and build up of reserves.

The full cost recovery process means the unit cost contains an element of core costs and is the modern way by which core costs are funded.

Price does not have to be the same as cost unless it states in a funding contract that the funder will only pay the cost incurred.

In a market economy, one charges what the market will pay. If you were providing a service for offenders in prison that meant they could be released early with no risk of them reoffending, then the Home Office would be likely to pay a very high fee, so long as it was cheaper than the alternative which would be the cost of keeping people in prison. Sometimes people charge less than the full cost because they are trying to get into the market or prove the need for an innovative service which funders are not yet keen to buy. Of course, you have to fund the loss from somewhere which is typically from reserves or from a funder who is providing core costs, or even from a funder who is paying over the full cost for a service.

Pricing systems

Government is expecting the voluntary sector to compete with the private sector. The main pricing systems used by the private sector are:

Skimming

Charging the maximum they can get and reducing prices as more customers come into the market, ie. as competition increases due to the high level of profits. from the high prices charged. Apple iPhones are an example. This pricing system is often used to recover research and development costs before competition pushes the price down.

Penetration

The supplier sells at a loss for a few years, and as the competition goes bust, the supplier increases its prices. The privatised Council refuge collection from your home operated like this. Initially, after privatisation, there were a lot of small contractors. A few larger players reduce their prices and so knock out a lot of the smaller suppliers. Now they charge at a higher price because there is less competition, so they make a higher profit than would be the case if there were a lot of suppliers in the market.

Cost-plus

Use full cost recovery and then add a bit extra for profit: 5% might be reasonable. This helps build up reserves which a charity may need to do if it is expanding or has to meet redundancy costs.

Cost

Use full cost recovery. Few things work out as expected so you will make a small loss or surplus.

Surge

When there is an underground train strike in London Uber increases its minicab prices by 200%. If you are supplying a contact and asked to do a bit extra, charge a high price because the purchaser is unlikely to go elsewhere.  Companies that remove asbestos from buildings charge a high price if asbestos is discovered during a renovation because the whole project will be stopped until the asbestos is removed. If the asbestos is spotted before the renovation starts, its removal can be planned into the work so it is not urgent and the price is lower.

Marginal Cost

Charge just the direct costs associated with the project and none of the indirect costs. Other projects are paying for all the indirect costs. This can be used for experimental projects which are difficult to fund. Once you have proved the project works, move it over to cost-plus pricing or skimming.

Full cost recovery and unit costs

Full cost recovery can be used as the foundation for calculating unit costs. Once you know your unit cost, fundraising applications become very simple. If an advocacy service cost £49.10 per hour and you believe a funder might provide £5,000 then you know you can offer them 102 hours of advocacy (5,000/49.10) or 100 hours if you want to make a small 2% surplus to build up reserves. You should estimate how many clients 100 hours would cover. If you reckon, on an average of 5 hours per client, then 100 hours will cover 20 clients.

In the above paragraph, we have estimated the average of all cases to be 5 hours. This approach can lead to cherry picking, just doing the simple cases and leaving the complex ones to be done by someone else or no one so your organisation makes a large surplus.  An 80:20 rule applies to a lot of behaviours. It may be that 80% of cases are simple and only take 2.5 hours and 20% of cases are complex and take on average 15 hours. You could bid for just complex cases or point out to the funder that 20% of the work will be on complex cases taking on average 15 hours each. Using the 80:20 rule £5,000 would pay for 16 small cases and four long cases.

The Riverside Elders model is a simplified form of full cost recovery. In more complex models the manager’s time and office overheads allocated to that time are reallocated to specific projects and to governance. The bit to governance then has to be allocated to the projects, and some people find the maths of this complicated.

Many calculations are an estimate – like how much stationary a project will use or how much of one member’s of staff time. The error in estimating is probably larger than any error created by using this simplified approach to full cost recovery.

If one wants very accurate full cost recovery, then your staff will have to fill in timesheets detailing how their time has been spent. Many firms use six-minute intervals because that divides the hour into ten. Discipline and time are required to fill in timesheets and time and technology are needed to process the information they contain. Small organisations often find this uneconomic and do not like the change in organisational culture that introducing detailed timesheets creates. Timesheets are only as accurate as the information recorded on them. If the timesheet is completed at the end of each day, it is likely to contain estimates.

In this factsheet we used time to apportion indirect costs, other cost drivers include floor space used, shelf space in supermarkets, and for vehicles mileage. You might use floor space to apportion an electricity bill or rent.

Apportionment can become internally political. A department that pays high rent for an office may feel unfairly treated if the whole rent is charged into its costs and could ask for the average rent of all the buildings used by the whole organisation to be added to its cost instead of the higher actual rent. There is no definitive answer to that one; it is a matter of judgement and systems to encourage good resource allocation. You do not want to get into a position where a department is closed due to high costs just because somebody signed a fifteen-year lease at the top of a property boom. The organisation will still be left with the lease!

It is important that you cover the direct costs of a project and a “fair” proportion of the indirect costs (overheads). At the end of the day if an organisation has provided a good service at a reasonable price, and recovers (is paid for) all its costs plus a contribution towards reserves, then it has got through another year, and everybody should be happy.

One of the issues with full cost recovery is you do not know how many of your bids will be successful. If you make five bids and three are successful how is the full cost recovering going to work?

If they were for equal amounts and you allocated 20% of the overheads to each bid then with only three being successful, you will have only covered 66% of the indirect or central costs. Is the chief executive going to be part-time and can you rent out the unfunded office space and 33% of the telephone line? Clearly no. So you have to make a judgement when making a series of bids as to what percentage are likely to be winners. If the figure is 66%, that is 3 bids out of 5, and the bids are of equal size, then you would apply 33% of the indirect costs to each bid, not 20%. That way all the indirect costs are recouped by the winning bids. If more bids are successful you win, if fewer bids are successful, you lose. However, be careful about contracts that just allow you to recoup costs.

A different approach to full cost recovery is absorption costing. It allows you to get a quick, simple handle on the indirect costs and apply it to all funding applications. We know from the Riverside Elders example that the advocacy service price is £50 an hour using cost-plus pricing.  The average time expended per client is 5 hours. So each client costs on average £250.   You now can look at the funding available and say how many clients we will help in the year. If a funder will pay up to £5,000 you can offer to assist 20 clients at a price of £250 per client, £5,000 in total.

CASH will be publishing CASHFACTS Unit costs & pricing soon. Follow/like us on Twitter and Facebook and/or subscribe to CASH eNEWS, and we’ll let you when it is published.

The Big Lottery

The Lottery has detailed guidance on full cost recovery and how it should be used when applying to them. It’s a lengthy guide so we are not suggesting reading it unless you are considering applying.

CASH Accountancy Services

CASH produces full costs recovery models for charities and social enterprises. A simple model for a funding application can be produced in a couple of hours for small organisations. We charge £60 an hour, see our CASH Accountancy Services.

This service is free for Kensington & Chelsea and Hammersmith & Fulham groups (we have funding to work in these Boroughs).

We can produce more complex, detailed models including the calculation of unit costs and incorporate these into QuickBooks and Sage.

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CASHFACTS Full cost recovery is reviewed at the start of every financial year. It may be amended throughout the year. If you want to be informed of major updates subscribe to CASH eNEWS or follow/like us on Twitter and Facebook.

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