Why cost analysis?
Although nonprofits generally have a good understanding of their revenues, knowledge about costs can sometimes be less robust. This is particularly the case when it comes to the true, all-in costs of providing services, running programs, and otherwise operating the organization.
Before you start conducting the actual analysis, make sure you:
Spend about one to two hours navigating through the six steps and glance over the FAQs.
Carefully review the "What do I need to get started?" section of the FAQs.
Read one or two case studies to understand how other organizations have used cost analysis.
Review the one-page process overview (print out a copy to serve as your overview/roadmap, if it is helpful).
If you would like to review these materials offline, please download the PDF version of this toolkit.
Lacking this information, nonprofit executives often must make important resource-related decisions on the basis of intangibles such as intuition, the skills and knowledge of the program staff, or the preferences and inclinations of the organization’s funders. As a result, they run the risk of undermining their organization’s mission (however inadvertently) by failing to allocate resources to the most appropriate programs and services. Given the limited resources available to nonprofits (especially during financially challenging times), gaining economic clarity around costs is critical to inform key strategic decisions.
What is true-cost analysis?
An effective true-cost analysis accurately allocates direct as well as indirect costs across focus areas such as programs, geographic sites or particular products, allowing nonprofit leaders to make more informed decisions about strategy and funding.
Most organizations have a good understanding of the direct costs incurred by each of their programs. But since traditional accounting breaks down indirect (or overhead) costs by functions (e.g. administration, marketing, operations), rather than by programs, it fails to capture the relationship between these costs and the organization’s activities, and consequently, its mission. The result is a cloudy economic picture that blinds nonprofit leaders from truly understanding the financial health of each of their program areas.
The allocation of all organizational costs, direct and indirect, across relevant programs/sites is at the heart of true-cost analysis.
Who should use cost analysis?
This toolkit is intended primarily for senior leaders (e.g. executive directors, directors of finance, development directors, regional directors) of small to medium nonprofit organizations with multiple programmatic areas or multiple geographic sites. It may also be useful for leaders of larger nonprofits in those cases where this knowledge does not exist already among the organization's staff. Smaller nonprofits with a single program area and a single geographic site are unlikely to require true-cost analysis as offered in this toolkit, which focuses on allocating financials across multiple areas.
This toolkit may also prove useful for foundations looking to understand their grantees’ true-cost structure, or to help their grantees gain economic clarity.
The toolkit assumes that its users possess a basic understanding of financial concepts and a strategic purview of the organization.
How do you actually do it?
The process of understanding the true costs of each program area within an organization can seem somewhat complex for anyone conducting this analysis for the first time. This toolkit has been designed specifically to help guide nonprofit leaders through this process, which consists of six steps:
- Determine purpose and scope
- Gather financial data
- Allocate direct costs
- Allocate indirect costs
- Check your data
- Apply this knowledge
At each step, the toolkit offers an explanation of how to conduct the analysis. For relevant steps, we also provide blank financial templates and concrete examples.