Full cost recovery

Full cost recovery remains a rarity for voluntary and community organisations (VCOs)
delivering government funded services. This arises from the continued lack of
understanding by funders over the legitimacy, necessity and practical application of full
cost recovery. Mixed responses from funders when VCOs demand recovery of full costs
and the fact that many VCOs are yet to establish an effective cost allocation system for
their services present further challenges.

Background Key research findings

The 2002 Treasury cross cutting review (CCR)
clearly identified the achievement of full cost
recovery as a key challenge facing the voluntary
and community sector (VCS) in relation to
government funding for service delivery.

There is little evidence of central and local
government funders paying full costs
because the majority are still failing to
understand full cost recovery or recognise it
as either legitimate or necessary.

This briefing presents a summary of the sector’s
experience of full cost recovery in service delivery
based on research carried out by NCVO in 2004.
It also points to recent developments in the move
towards achieving full cost recovery in both sector
and government policy to equip VCOs in the drive
to make full cost recovery the norm for all
contracts and grants.
What is Full Cost Recovery?
It simply means securing funding for
– or 'recovering' – proportionate
overhead costs, as well as the direct
costs of projects. Every organisation
needs to recover all its costs or it
cannot pay its employees, rent office
space, offer its products and services
or plan for future development and
delivery of its services1.

Failure to pay full costs leads to VCOs
subsidising public service delivery and has a
detrimental affect on VCOs’ staffing,
sustainability and future development. As a
result many organisations are forced to
reduce the volume or quality of services
they deliver.

Many VCOs recognise the importance of
recovering full costs and are willing to
collectively demand this from funders.
However, limited capacity within the VCS, in
terms of skills and knowledge, present a
challenge for establishing full cost recovery
as standard funding practice.

The templates for full cost recovery1,2
published by the Association of Chief
Executives of Voluntary Organisations
(ACEVO) are useful tools for VCOs in
determining cost allocations.
The sector’s experience

Since 2002 the amount of government funding to the sector for service delivery has increased. Public
funding now accounts for 37% of VCS income3. However, the majority of VCOs still remain unable to
recover the full costs of service delivery.

“It’s not a case of you make an application and you apply for it and it will
be there, usually there’s some shortfall.”

There is patchy evidence that some central government funders have become willing to pay full costs
since 2002.This includes funding streams from the Home Office, Defra, LDA and DoH (section 64)4.

The majority of local government funders are failing to pay full costs. However, the sector
recognises the funding limitations that local government can face.

“I think it’s sad really, it’s very hard for the voluntary sector to do any negotiation
with local authorities because they’re so strapped for cash themselves.”

Many funders do not understand the concept of full cost recovery or methods for pricing and
costing services.

“There is still a lack of clarity about what it is, despite guidance the statutory
services are saying ‘we don’t know what it means’ and will stand up and
argue what full cost recovery means with you.”

Local offices of national VCOs often find it hard to argue for including costs incurred by the central
office, such as management and health and safety.

VCOs feel that they do not compete on a level playing field with the public or private sector
because they are benchmarked against public providers who have their core costs covered by the
taxpayer, whilst they feel that the private sector is less scrutinised over costs.

“Nobody asks the private sector what the profit margins are, we get
our feet screwed to the floor if we offer poor value for money.”

Many VCOs lack the capacity to establish an effective costing system for achieving full cost recovery.
This is often due to limited knowledge and skills within VCOs.

Unfortunately government rhetoric regarding the importance of implementing full cost recovery and the
increase in money available to the sector has done little to establish full cost recovery as standard funding
practice. The lack of understanding around full cost recovery and how to allocate costs within both
funders and the VCS remains a key challenge.
The impact on the sector

Failure to achieve full cost recovery results in organisations subsidising service delivery.This practice is not
sustainable and jeopardises the future of both the services and the VCOs involved.

“… we are subsidising and there’s a tension heading up … at what point do we

finally creak and fall over because we haven’t got the resources there to pay for
the infrastructure that we have?”

The absence of full cost recovery for service delivery impacts VCOs’ ability to create new services,
train staff and plan ahead.This also means that staff are subjected to job insecurity alongside poor
pay and benefits as VCOs struggle with inadequate resources.

Some organisations find that when they try to include all costs in their funding application in order
to achieve full cost recovery they are discouraged from doing so by funders.

“We’ve been accused of being too honest … people should

be saying, ‘that’s great, that’s what we want to see.’ ”

Several VCOs feel that government funders view them as the low cost option where it is legitimate
not to fund core costs or overheads.

“I’ve heard it said: voluntary sector – soft touch, if there ain’t enough money
in your budget, give the charity a ring.”

Inability to recover overhead costs will inevitably lead to a reduction in the volume or quality of
service delivery by the VCS. It also means that funders get poor value for money because services
are neither sustainable nor cost effective.
The sector’s response

The development of the ACEVO templates for full cost recovery has been a productive step
forward in providing an effective toolkit for VCOs’ costs allocations. However, some VCOs still find
funders questioning the allocation of funding.

VCOs recognise that there is a poor understanding of the concepts of pricing and costing
within the sector while others highlighted that the arbitrary method of calculating core costs
by percentage is not useful for small organisations.

“I think the sector’s got to enhance its own understanding and then it’s
got to do the usual thing and collaborate and make its case.”

Another approach used in Canada5 for allocating costs has been to organise funding into a
series of cost centres where each is a major category of activity such as counselling or
children’s programmes. Within each cost centre services to be provided are specified.Then
funding is provided for staff, overheads etc for that service. Funds may be transferred within
a cost centre but not between them.

VCOs who have demanded full cost recovery have encountered different outcomes. Some
funders have agreed to pay full costs, whilst others have re-tendered contracts or allowed
services to close.

“We started talking about this extra funding … we said ‘we know that to
provide our services, what we need to do is fund core things’, so they gave
in at that point and said, ‘yes, okay’.”

A number of organisations recognise the strength of VCOs collectively demanding full cost
recovery despite the uncertainty surrounding funders’ responses. There is also a genuine
desire for more VCOs to feel able to walk away from contracts if their full costs are
not covered.

“The sector’s got to stand together and say we will not be split on this,
either you, the major funders, sort this out or we’ll be withdrawing
our labour.”
What next?

The failure by government funders to implement the recommendations of the Treasury CCR
has been highlighted by the recently published NAO report, Working with the Third Sector6,
which states:

“There has been progress since the 2002 Treasury Review, but not enough.
Whilst the Home Office and the Treasury have sought to push matters forward,
a significant gap remains between the principles set out in the review and
subsequent practice.”

More specifically the report identifies that since 2002 “there has been little progress on reimbursing the
full costs of service delivery”.The report goes on to recommend the development of new and additional
guidance for funders on how and when to apply the principle of full cost recovery.This will complement
the guidance produced for the sector by ACEVO1,2.

Recent responses by the government to the issue of full cost recovery have included comments made by
former Charities Minister Fiona Mactaggart who called on VCOs to walk away from poor contracting
processes, particularly contracts that are funded below full cost7.

In addition, this year’s Budget contained a government commitment to update the Treasury Guidance to
Funders8.This would include an emphasis on the importance of full cost recovery.

The Compact Code of Good Practice on Funding and Procurement9 also underlines the fact that no
activity can be carried out without incurring indirect or support costs and aims to ensure that “funding
reflects the full cost of the service, including the legitimate portion of overhead costs”.

The Home Office is working closely with other Government departments to ensure that the Compact
is implemented in the Department’s engagement with the sector. Each department is developing its own
funding strategy in compliance with the Compact. Although the code is written for the relationship
between central government and the VCS it also aims to influence funding practice by local government
and local public sector bodies through the development of Local Codes of Good Practice.

The government is acknowledging the legitimacy and necessity of full cost recovery and is encouraging
funders to put it into practice. So far the Treasury CCR recommendations have not been implemented
but with increased efforts by the government and further promptings through the NAO report the sector
is in a strong position to start to expect funders to have to argue against full cost recovery, rather than
for VCOs to have to argue for it.
Want to find out more?

Essential reading
O ACEVO’s template for allocating costs for small VCOs, Full Cost Recovery: A guide and toolkit on
cost allocation1
O ACEVO’s template for allocating costs for large organisations, Funding our Future II: Understand and
Allocate Costs2
O Paragraphs 2.10 & 3.6 and Appendix D of Funding and Procurement: Compact Code of Good Practice9
O Shared Aspirations, NCVO’s policy report10
O Part 3 of the National Audit Office’s 2005 report on government funding of the VCS for service
delivery, Working with the Third Sector 6

Recommendations for voluntary and community organisations10

J VCOs must own the principle of full cost recovery.They should move towards the language of a price
for delivery if they are bidding for a contract, and away from the language of core and project costs.
J VCOs need to ensure that they cost contract bids appropriately, using the tools that have been
developed, including the ACEVO full cost recovery template. This will give both funders and the
sector the confidence that they are seeking appropriate resources.
J If VCOs do accept anything other than full cost recovery, they need to be very clear about the
reasons why. Most importantly, this must be the decision of the organisation concerned and not
the funder.
J VCOs need to consider walking away from or refusing to accept under-funded contracts. As well
as damaging the sustainability of VCOs, under-resourced public services run contrary to the best
interests of service users.

About the project – a brief outline of the research

In 2004 NCVO carried out research into the VCS experience of government relationships funding for
service delivery. This research was carried out as part of the National Audit Office’s assessment of
progress made on implementing the funding recommendations from the 2002 Treasury CCR. A range of
methods was used: an on-line consultation, focus groups, in-depth interviews and consultation workshops.

References
1
Full Cost Recovery: A guide and toolkit on cost allocation, ACEVO, 2004
2
Funding our Future II: Understand and Allocate Costs, ACEVO, 2002
3
The UK Voluntary Sector Almanac, NCVO, 2004
4
‘Section 64’ refers to funding for health development projects of national significance, funded by the Department of Health under Section 64 of the Health Services and Public
Health Services Act 1968
5
Funding relations between nonprofits and Government: A positive example,Laura K Brown, Elizabeth Troutt; NVSQ,Vol 13, No 1, P. 5-27
6
Working with the Third Sector, National Audit Office, 2005
7
Fiona Mactaggart keynote address at the Funding Our Future conference in London on 17 November 2004
8
Guidance to Funders, HM Treasury, 2003
9
Funding and Procurement: Compact Code of Good Practice, Home Office & Compact Working Group, Home Office 2005
10
Shared Aspirations: the role of the voluntary and community sector in improving the funding relationships with government, Mubeen Bhutta, NCVO, 2005