Tag Archives: Cost Allocation

Cost Allocation

The Secrets of Cost AllocationA few years back I co-wrote an article about getting accurate numbers from your financial system for the California Association of Nonprofits that was based on a workshop I developed. These next two blog posts will excerpt some of the material from that piece. For folks who would like the whole article you can click the above link. This first post will be on cost allocation, the second post will be on setting up a functional accounting system.

Cost allocation should not be ignored as a cornerstone of your financial management and reporting. It is critically important to all aspects of your organization: How you budget from year to year, how you make management decisions, how you appear to potential supporters and the amount you are reimbursed for services all depend on proper and consistent cost allocation.

Allocation can look tricky at first glance, and initially it can be difficult to set up a reliable, consistent and simple system. But once your system is in place, it should go rather smoothly and become a routine part of your accounting and financial reporting process. Put some thought and planning into developing a method that works for you and that best reflects the reality of what happens in your organization from day to day.

Cost allocation is a method for apportioning shared expenses or shared costs (also called common costs, or directly allocable costs) across functional areas. It generally works well to “dump” all shared costs into cost centers – temporary holding tanks for functional areas – and then allocate them out across those functional areas on a periodic basis, usually monthly or yearly.

As an example say you get a bill from your office supply store for $500, you would initially expense it to “Supplies” and code it to a cost center. But at month-end, year-end or whenever you allocate costs, you will want to divide out that $500 between the specific functional areas that actually used the office supplies. So you might end up with $50 of that bill being allocated to management, $75 to fundraising and $375 proportionately across various programs. Your allocation method is your way of deciding what percentage of that bill to apportion to each functional area.

Cost allocation is important because, done accurately and consistently, it can provide a realistic picture of what different programs and other activities cost. Your allocation method also determines the percentages of program, management and fundraising that will appear on your Form 990 and other reports – numbers that potential donors use to judge your organization’s worthiness for their contributions. It is also used in cost recovery for reimbursable expenses, directly impacting your bottom line and related fundraising decisions.

There are a number of cost allocation methods out there, and several of the most common are:

  • Payroll. Allocations are based on a percentage of the total actual time worked or the total payroll dollars charged by all employees in each functional area. For example, four employees’ time sheet data shows that they spent 15 percent of their aggregated time during the last payroll period on Program A, 35 percent of their aggregated time on Program B, 25 percent on program C, 15 percent on Administration and 10 percent on Fundraising.
  • Cost-to-cost or direct cost. Allocations are based on the previous year’s percentage breakdowns for each functional area.
  • Square footage. Allocations are based on the proportionate space occupied by each functional area in your office or worksite. For example, Program A occupies 10 percent of your office space, Program B occupies 20 percent, Program C 50 percent, Administration 5 percent and Fundraising 15 percent. This method is useful for allocating rent, utilities and other occupancy-related costs.

Your organization might require a method not included above, or more than one method of cost allocation, for example using payroll for personnel-related expenses and square footage for office-related expenses. You might have to pick and choose which method or methods work best for your organization in terms of both your available time and the accuracy of the data produced. That said, if you have many different allocation methods, some consolidation might be in order. Whatever method(s) you decide to use, you should use it consistently, put it in writing, have it approved by the executive director and be able to back it up if questioned about it. It should also be honest and ethical – not a method you would regret being described in a front-page story in your local newspaper.

If you would like to learn about creating a cost allocation policy for your nonprofit please click on the image below.

My Financial Management Plan

Financial Management

MFMP-logoI have written before about creating policies for your nonprofit. Now nonprofits have a new tool they can easily use to create their own financial management policies and plans. The Nonprofit Risk Management Center has a new tool called My Financial Management Plan where users can go through up to 21 different modules on nonprofit financial and accounting topics to create a variety of policies and procedures to help manage, organize and streamline their financial operations. From the Risk Management Center:

Nonprofit leaders have spent countless hours developing the necessary components of a financial management plan. But for many organizations the components, from an annual budget, return on investment strategy, cash flow planning tool and more, remain disparate. The nonprofit lacks a cohesive plan that reflects the organization’s commitment to the effective stewardship of its assets. My Financial Management Plan was created to guide leaders in updating the components of their financial management systems and integrating these components into a cohesive plan. This powerful system features covers topics such as Board Fiduciary Obligations, Managing Fraud Risk, Managing Cash Flow, Return on Investment Analysis, Cost Allocation, Classifying Net Assets, Managing Cash Flow, Budgeting, the form 990 and Grants and Contributions.

My Financial Management Plan is a powerful tool to turn financial management strategies, policies and protocols into a plan that will help your nonprofit demonstrate both competence and accountability. Use the “Plan Modules” feature to go through the 22 system modules. Each module offers the opportunity to upload existing material from your financial management system, create new content (based on our templates or created “on the fly”), or skip sections you don’t wish to use. Use the “Manage My Plan” feature to edit your draft plan, upload supporting PDF files and view/download your plan. The system also features a classroom with easy-to-understand articles and resources on a wide range of financial management topics.

I was fortunate enough to work on this project and create a lot of the module content. I know that this will be a great tool for nonprofits to learn about what they need know about with regards to their nonprofit’s finances and creating the appropriate policies and procedures to ensure good financial stewardship. For those not ready to buy access to the program you can register with the site to receive periodic email updates on nonprofit financial issues.

If you have any questions or comments about the program please let me know via email or in the comments below.

Workshop Resources, Questions and Answers

Questions?As part of my follow-up to recent workshops that I’ve run in the last few weeks I wanted to answer a few questions.  But first I wanted to thank Alltop.com for including this blog in their list of nonprofit blogs.  It feels great to be in such respected company!

Managing the Money, Managing the Organization

For the Managing the Money, Managing the Organization workshop in Long Beach, you can download the handouts from the event here.  For those who are interested in looking at a budget narrative I have linked to a PDF of one here.  An online search of “sample budget narrative” will reveal a lot more.

Building Financial Literacy

From part one of the Building Financial Literacy workshop in Ventura there was a question about vehicle donation guidance.  I would refer all those interested in this to this PDF from the IRS. For other IRS contributions and donation information please check the IRS links and resources to the right. For the folks who wanted information on how to value in-kind donations, please click here.

Nonprofit Summer School

Thanks to all the folks who spent the day with me talking about nonprofit accounting issues at Cal State Fullerton’s event. Many of the questions were about QuickBooks issues, I would direct you to this page of the site for more information and resources.

For more information and resources I usually mention, please check here. And if I missed your question or you have others please feel free to remind me!

More Questions and Answers – Donated Items and Services

I have received a rash of questions lately on donation and valuation information for in-kind gifts.  I mentioned my post about valuation information above.  I have another post about how to enter in donation transactions and another on valuing donated services.  I hope those help.

More Questions and Answers – Employee Time and Cost Allocation

Question: We are just starting our marketing and communications program (hiring a marketing manager, revamping our website, etc.). I do not believe that I should classify 100% of these costs as fundraising (the website is mostly about information sharing and public relations). Rather I consider classifying some as program costs, some as administrative expenses and some as fundraising depending on the activities purpose. Is that correct?

Answer: Yes. Not all of the costs described should be lumped into fundraising. The costs should be allocated between programs, admin and fundraising as appropriate.

For example, the marketing manager spends time designing some promotional materials to get word out about a particular program you do. I’d say that is a program expense. Weather particular funder allows their money to be spent on advertising is a separate matter, but the expense is still a program expense. If that same person is designing something to be used for a fundraising gala, that would be a fundraising expense. If they are designing new signage for your offices? The expenses would probably be administrative.

You can click here for many more questions and answers.