Enhanced Management Strategies for Indirect Costs

There are many aspects to consider when it comes to managing a nonprofit organization’s indirect costs. We often think first about compliance rules, which are naturally complicated and can vary by funding source and an organization’s own internal accounting policies and procedures. One aspect we tend not to emphasize enough is staff and their propensity to be disinterested and disconnected when it comes to considering and managing indirect costs.

To manage indirect costs effectively, we must raise staff’s understanding and awareness of indirect costs and sensitize them to the impact indirect costs have on an organization’s reputation, sustainability, and financial health. Simply stated, nonprofit organizations will appear in a better light when management and administrative (M&A) expenses are lower (where indirect costs reside), and program costs are higher. Staff can be your frontline source for effectively managing indirect costs.

Organizations need to move away from the natural tendency to consider all shared costs as indirect and only single-purpose costs to be direct. Most costs incurred by an organization can have multi-use purposes. This is true for many regular budget line items such as labor, printing, and professional fees.

A shared cost can often be treated as a direct cost if the shared cost can, with proper supporting documentation, be disaggregated and allocated. Moving thinking in this direction requires raising staff’s awareness and motivating them to put in the extra effort to disaggregate costs and document allocations to programs and activities and away from M&A.

Recognize that this can potentially be a hard behavior to change. To drive home this point, start by challenging staff to presume that shared costs are direct program costs unless the circumstances clearly show they are not.

Also, assess whether changes are needed to the organization’s internal accounting procedures to move away from old practices that automatically treat all shared costs as indirect and thereby assigned to M&A. For example, consider requiring documentation and management approval before shared costs are assigned to indirect costs.

In addition, as we’ve discussed in this article, using actual time tracking systems instead of estimated labor allocations is another change to internal accounting procedures to consider.

Planning Tip – It is important for nonprofit organizations to actively manage indirect costs. Adopt the same approach as preparing a program budget. Identify individual indirect cost budget components, document related assumptions, and provide supporting calculations. Use this information to prepare performance assessments for indirect costs and report changing trends compared to budget expectations. Regular budget performance assessments will help curtail the ballooning indirect costs that result from under-allocation of shared costs to programs and activities.

When most shared costs end up in M&A, program and activity costs will appear lower than they are in reality. Not knowing the “true” full cost of programs and activities can cause future planning mistakes. This can lead to lower asks for contributions, accepting underfunded grants, mispricing of registration and sponsorship fees for events, etc. Conversely, knowing the true full cost of programs and activities is essential for future strategic planning, realignment of programs and activities, and allocation of resources.