The Importance of Understanding What It Really Costs to Deliver Programs
October 17, 2016
In 2015, NFF kicked off a blog series that highlights some of the common challenges faced by 17 human services organizations that participated in NFF’s Community Resilience Fund (CRF) initiative, an effort designed to strengthen New York City’s social safety net. In March 2016, a shockwave rippled through the human services sector in NYC when its largest human services provider, Federation Employment and Guidance Services (FEGS), unexpectedly declared bankruptcy. The loss of such a major service provider has raised questions about the field’s financial health, risk tolerance, and the persistent issue of government contracts that don’t yet cover the full cost of program delivery – let alone support the institutions that run those programs.
Multiple factors contributed to the demise of FEGS; however, one key issue was the struggle to account for the real cost of programs and services in order to determine whether government contract revenue (the primary source of funding for FEGS) was covering those costs. At first glance, it may seem like a straightforward process to weigh contract revenue against program costs, but nonprofits are often so deeply entrenched in parsing their financial data for contract compliance that their view of program costs can end up conforming to funder regulations rather than what programs actually cost to deliver. Compliance reporting is, of course, essential for nonprofits as a means of collecting payment for services provided, but looking at program economics only through the lens of compliance reporting does not support strategic decision-making, particularly around whether a nonprofit can truly afford to take on a given contract.
NFF encourages all nonprofits, whether they have government contracts or not, to ensure they have a full understanding of what it really costs to deliver programs.
The Committee for Hispanic Children and Families (CHCF) is an NYC-based human services provider that combines education and advocacy to strengthen and expand opportunities for the Latino community, both locally and nationally. NFF partnered with CHCF through the CRF initiative at a time when they were facing several significant changes, including the retirement of their founding CEO, the end of a favorable long-term facility lease, and term changes for several key government contracts. Given these varying dynamics, CHCF needed to better understand their business model and the true cost of programs to inform decisions about their future.
Teamed with CHCF’s chief financial officer and program director, we sought to answer two key questions:
Which of CHCF’s programs provide the most subsidy to the organization, and which programs require the most subsidy from the organization?
What is the true cost of running each of CHCF’s programs (fully loaded with infrastructure and administrative costs), and are program grants and contracts fully covering those costs?
In order to answer these questions, we developed two distinct views of CHCF’s program economics with a close look how program costs could be interpreted:
Direct View of Costs – This analysis answers the question, “What are the revenues and expenses attached exclusively to this program?” We strip away all allocations and allowances, as well as the administrative overhead costs required to run the larger enterprise, since those will be incurred regardless of whether a program is offered or not. This view allows a nonprofit to identify the financial impact that each program has on the enterprise bottom line and is the best way to determine the immediate financial impact of taking on a new program, or cutting or expanding an existing program.
Allocated View of Costs – This analysis includes not just the direct program costs but also an allocated portion of administrative overhead. Unlike the direct view of costs, this allocation reflects the portion of staff time and other administrative resources actually needed to deliver that program (i.e., a proportionate amount of office space and resources, as well as the amount of time it takes for staff to manage program grant reporting or develop new program strategies). Because this view provides a more comprehensive and holistic view of what it costs an organization to deliver programs, this is the best analysis to use when developing funding proposals. It also provides a useful framework for determining whether a given contract covers its “fair share” of administrative costs.
In comparison, a compliance-based view reflects only the costs allowable under the contracts that fund a given program. While presenting data this way is necessary for tracking how funding should be spent, this view often provides an incomplete picture of what it truly takes to run a program and does not reflect how the nonprofit actually spends its money.
The table below provides side-by-side comparison of when to use these analysis methods and how they can be helpful in decision-making.
Identifies the marginal cost of the program and identifies the financial impact that a program has on the organization’s bottom line
Captures all resources used to deliver each program (including resources shared with other programs)
What it tells you
What program costs are we allowed to charge to this contract?
What would happen to our organization’s overall surplus/deficit if we added, changed or discontinued a program?
Which organizational resources (staff and other than personnel) are used to deliver this program?
CHCF leadership intimately knew their programs and the value that each brought to the organization’s mission, but were less clear about the full costs of delivering each program. We worked with leadership to outline both direct and allocated views of program economics to see how each program really fit in to the organization’s business model. Undertaking this work required a paradigm shift that meant (temporarily) abandoning many of the compliance-based analysis methods that leadership previously relied on when looking at costs. Ultimately, what emerged was a clear picture with definitive conclusions about which programs were underfunded and by how much. CHCF realized that although one of its major contracts effectively covered direct program costs, the contract was underfunding the necessary administrative support so severely that it challenged CHCF’s overall financial stability. Based on this new view of the program’s financial performance, CHCF leadership decided they had to discontinue the contract in order to ensure that they could continue delivering on the rest of their programs.
Certainly, compliance reporting is a crucial component of managing grants and contracts, but without understanding the full costs associated with each program, nonprofit leaders will not have sufficient data to make decisions about pricing for potential contracts or grants, the financial effect of growth or change, or which levers might truly be connected to improving the organization’s financial bottom line.
In response to FEGS’ closure and the threat of more closures among nonprofit human services providers, NYC’s Human Services Council created a special Commission to understand contributing factors to this trend, from management and oversight to challenging financial environments. With participation from NFF and other experts, one imperative has become clear, which is that NYC’s human services providers must better understand their own program costs and assess the financial impact of grants and contracts. Organizations that employ the direct and allocated cost analysis methods outlined above will be better positioned to make strategic choices about funding opportunities; this means thinking twice before accepting or continuing funding for a program that might ultimately destabilize an organization’s financial health, or even jeopardize its viability. What’s at stake is not just the financial health of human services organizations, but the ability of the sector to provide critical services to people who rely on them in NYC and across the nation.
Authored by: Jina Paik, Director for Advisory Services Sonia Montoya, Manager for Advisory Services Philip Rosenbloom, Senior Associate for Advisory Services (NFF Alum)