Week 5 Notes
Costs Are Cool: The Strategic Value of Economic Clarity
Core Idea:
Nonprofit organizations often lack a clear understanding of their true costs,
leading to suboptimal resource allocation. Economic clarity, achieved
through accurate cost data, enables better decision-making and
maximizes social impact.
Why Economic Clarity Matters:
Trade-offs are Inevitable: Nonprofits constantly make trade-offs due to
limited resources.
Resource Allocation is Key: Resource allocation decisions are a powerful
lever for achieving organizational goals.
Weak Cost Data: Many nonprofits have weak knowledge of the true, all-in
costs of providing services and running programs.
Informed Decisions: Economic clarity allows for resource-related decisions
based on data rather than intuition or funder preferences.
How Economic Clarity Informs Resource-Allocation Decisions:
1. Which programs do we fund?
a. Full cost information allows decision-makers to modify resource flow for
maximum impact.
b. Example: An organization shifted resources from a resume-services
program to an employment-services program because the latter had a
greater impact on economic self-sufficiency, despite similar costs.
c. Example: Another organization increased funding for its youth-services
program because cost analysis showed high-impact results at a low cost.
d. Example: A nationwide education organization reevaluated regional
offices after cost data revealed significant variations in the cost of
teacher training, leading to resource reallocation and knowledge sharing.
2. Should we expand to a new location?
a. Understanding cost distribution is crucial when considering expansion or
replication.
b. Opening a new site can bring economies of scale by sharing costs, but
also incurs unique start-up and site-specific costs.
c. It is essential to evaluate which costs will recur at the new location and
which can be leveraged from the original site.
d. Example: A workforce-development program decided against expansion
due to high overhead costs that would be unsustainable for a single
replicated program.
e. Cost Per Outcome: Linking unit-level economics with organizational
impact; requires clarity on outcomes and full costs.
3. How much money do we need to sustain our programs?
a. Good cost information helps organizations better ascertain the proper
amount and types of funding needed.
b. Organizations often approximate funding requests, but understanding
full costs allows for more accurate proposals.
c. Accurate cost data can enhance credibility with donors.
d. Nonprofits often underprice earned revenue products/services, and
accurate cost data can help inform pricing strategies.
Maximizing Impact through Economic Clarity:
Accurate cost data allows for a strategic view of program finances.
Decision-makers can see which programs cover their costs or generate
surplus funds, and which require subsidies.
This enables better decisions about allocating scarce resources to
effectively advance the organization’s mission.
Chapter 9: Cost Accounting: How Much Does It Cost?
Core Idea:
Understanding the true cost of providing services is crucial for
nonprofits, especially in challenging economic times. Cost accounting
helps determine efficiency, supports budgeting, enables comparisons,
and can be valuable for political and grant-winning purposes.
Why Cost Accounting Matters:
Internally: Helps in decision-making (e.g., program profitability, cost
differences between similar programs).
Externally: Can be used to demonstrate cost-effectiveness to funders
and other stakeholders.
Historically: Important for compliance with government regulations and
rate-setting, but now increasingly valued for internal management.
Cost Accounting as Management Accounting:
Relies on sound financial accounting.
Focuses on concepts unique to the institution.
Standardization is needed for external comparisons.
Direct vs. Indirect Costs:
Direct Costs: Easily identified with a specific service (e.g., salaries of
service providers, supplies, equipment).
Indirect Costs: Overheads necessary for doing business, but not
directly attributable to a single service (e.g., CEO salary, legal advice,
rent).
If a nonprofit provides only one service and doesn't fundraise, indirect
costs are minimal. Otherwise, cost accounting is essential.
Program vs. Support Activities:
Program Activities: The core services the nonprofit exists to provide
(also called mission centers, direct services, etc.).
Support Activities: Activities that support the delivery of program
services (e.g., bookkeeping, marketing, fundraising, also called service
centers, administrative services).
Key Aspects of a Good Nonprofit Cost Accounting System:
1. Distinguish Between Direct and Indirect Costs: Essential for
understanding true costs.
2. Assign Support Costs to Other Support Costs: Distribute certain support
costs (e.g., occupancy) across all services (program and support)
before allocating remaining support costs to direct services.
Indirect Costs - The Slippery Character:
Defining indirect costs can be subjective, making comparisons
between organizations difficult.
Internal comparisons are still valuable for calculating actual costs of
providing services.
Allocating Support Costs:
Support costs should be allocated to other support services before
being distributed across program services.
The goal is to determine the "fully loaded" cost of each program (direct
costs + allocated support costs).
Divide the total costs by the number of units of service to arrive at a
per-unit cost.
Step-Down Analysis:
A method for allocating costs where support costs are allocated in a
specific order, starting with those affecting the most other services and
support costs.
Each column picks up its share of costs from the one to its left and
then "steps down" to the remaining columns to its right until all
indirect costs have been allocated.
Allocation Methods:
Common Bases:
o Cost per square foot (for occupancy expenses).
o Percentage of payroll.
o Percentage of total revenue.
Challenges:
o New services may require disproportionate management
resources.
o Some programs may require more administrative support than
others.
Time Reporting: Actual time reporting is often the best source of
guidance about how to charge time.
Class notes
We want to do a cost analysis ourselves and have the answer to the question
What does this cost?
Cost Accounting Data
o What are the direct costs?
Easily and directly attributed to myself and my work
Seen this in cost of accounts and statement of functional
expenses
The budget
o What are in the indirect costs?
Costs that are not easily and directly attributable to unit
Support
Overhead
Administrative
o Fixed costs-regardless of volume the costs are incurred
Ex; classroom
o Variable costs- vary based on number of individuals you serve or
unites you produce
Ex: Curricular permissions
Full Cost = Indirect Costs + Direct Costs
Full Cost = Fixed costs + Variable costs
Break Even Analysis
o B = F + (V) (U)
B = Break even
F = Fixed Costs
V = Variable costs, expressed per unit of service
U = Number of unites served
If you calculate program costs to make it clear how many hours things
like infrastructure are being used per program this could reassign
some overhead costs to program costs
Chart of Accounts- anything that can be made a direct program cost
should be if it is core to the mission
Growth and scale are embedded in cost accounting
Cost is not always price
Cross subsetization
o Not every program is going to cover its full cost
Herzlinger: 4 “Gist” Questions – Lots of Answers/Data – Many potential
“It Depends” Decisions
o Are the organization’s goals consistent with its financial
resources?
o Are the sources and uses of financial resources matched?
o Is the organization maintaining intergenerational equity?
o Are present financial resources sustainable?
The above questions are board level strategic questions
First 3 questions are present past and the last question is future
Underfunded aspirations
Short-term money
Long-term money
Intergenerational equity issues
o Are inherited
Ratios- no fancy math
One number over another number, straight division
Ratios give us the answers to some questions that the numbers alone
cannot tell us
Start with the issues and the questions
o Common-sizing – percentages/pie chart
Simplest ratio, out of 100%
Think pie chart
Dividing of 100%
No fancy math
o Liquidity
Tells orgs how they are doing on cash
How much months of expenses are on hand
Are we liquid or not?
o Profitability
Making or losing money as a whole org or by program or
both
o Efficiency
How much does it cost to raise a dollar?
Take fundraiser cost and divide by total money brought in
o Debt structure/leverage
o Long-term viability
Percentage growth in net assest over time
Are we getting stronger or weaker in the long term?
