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Home Blog & Media Harmonized financial reporting could help NPOs to improve their financial health and resilience

Harmonized financial reporting could help NPOs to improve their financial health and resilience

May 24, 2022

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Author

Siham Bortcosh

Associate Consultant, UK

From 2020 to early 2022, I was lucky enough to lead the research team and subsequently co-author Humentum’s “Breaking the Starvation Cycle” report. Commissioned by a collaborative of private foundations, the research gathered evidence on the extent to which international donor funding covers the real administration costs of a range of national NGOs in ten countries in Africa, Asia, Latin America, and Europe. I’ll be part of a panel discussing the implications of the report on June 15, alongside leaders from some of the donors and NGOs involved in our research.

I’m no slouch when it comes to cost recovery, having worked in this area for longer than I care to think about, and seen “the good, the bad and the ugly”. But even I was taken aback by what we found. Perhaps the most concerning finding was that half of the NGOs had unrestricted reserves equivalent to 21 days or less of annual expenditure. And the research showed that 2/3rds of the restricted funding agreements reviewed in the study provided less than their fair share of administration costs[1]. Many participants told us in the research survey that essential functions such as safeguarding[2] and fundraising/business development are under-funded in their organisation.

This day to day reality for management in national NGOs really struck me. In our report, we’ve started by making specific recommendations for funders to change the practices that put NGOs in such fragile financial circumstances. But I also began to wonder about other sector-wide changes that could help, and my thoughts turned to the IFR4NPO initiative. What learning and insight does this ground-breaking research offer the development of the world’s first internationally applicable financial reporting guidance for non-profit organisations?

Well, quite a lot, as it turns out.

Unrestricted funds

Very strikingly, the research showed that having good “income quality” is very important – likely essential – for an NGO to have good financial health. Good income quality means having funders that make a fair contribution to administration costs. It also means having reasonable levels of unrestricted income that give financial management flexibility and help to mitigate adverse or unforeseen events. The IFR4NPO Guidance could give real impetus to the pursuit of good income quality by requiring NGOs to split their income between restricted and unrestricted funds, and to monitor their unrestricted results and reserves. What gets measured gets managed, after all. And it should provide a push to donors to give more unrestricted funds as part of their overall giving portfolio.

Fair share of administration costs

Secondly, the research looked at 286 restricted funding agreements from 92 donors, and assessed them according to a key measure defined in the research – the “extent of recovery of administration costs[3].  This indicates the extent to which that funding source provided the NGO with the full amount of the administration costs associated with funded project. We found a very wide range for this measure across the agreements we looked at. with 2/3rds of the agreements not covering their full and fair share of administration costs. Perhaps most interestingly, we found a very wide variation even in grants from the same funder. When some funders don’t provide adequate coverage, NGOs often have no choice but to use more flexible income to cover the gap – income that could (and really should) be invested in organisational development if it wasn’t being hoovered up to make up for the partial funding offered by some donors.  It’s fair to say that many donors – including those that funded this research – are trying hard to improve their policies in this area by paying their full and fair share, or even more, but their efforts seem often to be sabotaged by the “free riders” that pay too little in administration costs.

So, how could the IFR4NPO Guidance help?  One idea is that it could require disclosure of the extent of recovery of administration costs from the NPO’s major funding sources within the income notes. Such transparency would increase pressure on the donors who provide inadequate coverage of administration costs, and give visibility in the NGO community to what recovery might be possible with some donors – if they ask and negotiate!

Administration cost rate

Thirdly, the IFR4NPO Guidance could help us on our way to the ultimate aim of harmonised cost coverage if it provided a definition of administration costs and required disclosure of the NPO’s administration costs each year (from which a rate can be calculated). 

But – and there is a very big but – the Guidance would also need to be accompanied by work to change mindsets and thinking, for NPOs and donors alike, about administration costs.  There is a very entrenched and pervasive culture among funders and among NGOs themselves, that a low administration cost rate is a sign of efficiency. In fact, my conclusion from our research is it’s more likely to be a sign of risk!  Low rates can often signal what we called “missing costs” in the research – all the activities required to manage the NPO well and mitigate its risks, that it simply can’t afford, and which don’t therefore appear in its cost base and its administration cost rate. Requiring disclosure of an NPO’s administration costs in its accounts under the IFR4NPO Guidance may deepen the pressure to suppress administration costs, in organisations that are already under enormous pressure to make very difficult choices between functions they know to be essential.  It might even introduce a reluctance to apply the Guidance. A shift in thinking around administration cost rates is necessary – and the donor community has to actively start signalling that it does not view low rates as a “good thing”.

Policy disclosure

Lastly, learning from the implementation of the UK SORP tells us that when disclosure of a policy or practice in a particular area is required by the applicable accounting standard, it gets attention at management level. The research showed how important it was for NGOs to have adequate unrestricted reserves – and therefore to pursue any unrestricted funding sources that may be open to them, including making the case to funders that a portion of a grant – or indeed a whole grant – should be unrestricted. It also showed how critically important good cost recovery policy and practice are to ensuring adequate administration cost recovery from restricted funds. The IFR4NPO Guidance could help to focus both donor and NPO management attention on these areas – by requiring disclosure in the annual report of the NGO’s reserves policy, and of its cost recovery policy and key practices. 

Our research showed that good income quality and effective cost recovery practice both seem to be necessary for an NGO to achieve good financial health. One or the other alone didn’t seem to lead consistently to good financial health. In developing internationally applicable financial reporting guidance for NPOs, IFR4NPO can play a big part in making a decisive shift in the funding landscape – so that NPOs can enhance and maintain good financial health.

Siham Bortcosh will be part of a panel discussion being held on June 15 from 10:00 – 11:30 AM ET on the implications of Humentum’s research and the recommendations made in the Breaking the Starvation Cycle report. The other panelists will be:

  • Aidan Eyakuze, CEO, Twaweza
  • Kathy Reich, Director, Building Institutions and Networks (BUILD), Ford Foundation;
  • Tim Boyes-Watson, Global Director, Humentum
  • Dr. Christine Sow, CEO, Humentum (moderator)

To book a free place please register here

[1] The study used a standardised cost classification methodology to assess the cost recovery of up to nine restricted funding agreements (over three years of data) of each NGO.

[2] Safeguarding refers to the responsibility of organisations to make sure that their staff, operations, and programmes do no harm to children and vulnerable adults, and that they do not expose them to the risk of harm and abuse. It covers both prevention of sexual exploitation and abuse and other forms of potential harm

[3] This is the difference between the full and fair share of administration costs that should have been provided by the restricted funding agreement in accordance with the NPO’s administration cost rate, and the administration costs actually provided by that agreement (whether recovered via an indirect cost rate or as direct line items), as a proportion of the full and fair share of administration costs that should have been provided by that agreement