By Marcus Coetzee, 23 April 2020.
This article will help you to think more broadly about developing project budgets for your funding proposals and donors. It will highlight four budgeting methods to include in your toolkit. This will help your organization to be more prepared, versatile and likely to build (as opposed to consume) its financial reserves.
But first some context. Non-profit organizations tend to rely on grants for their survival. Grants are like donations, except they require funding proposals, budgets and contracts. Fundraisers must be skilled at developing a narrative for how a project will achieve its impact, and how the anticipated activities and costs will serve this purpose.
Organizations that don’t understand their donors’ appetite for grant size and risk may submit project budgets that are too low in order to be more appealing. However, they are also more likely to develop cash flow problems and use up their financial reserves. I’ve noticed that these organizations tend to rely on a single method for developing project budgets. They also tend to lack bargaining power with their donors.
In contrast, I’ve worked with several organizations that routinely get the full funds they need for their projects. I’ve noticed that they tend to use a variety of methods for developing project budgets. They have also developed innovative products, and have used marketing and PR to bolster their bargaining power.
In this article I will discuss four methods of developing project budgets. I start with the most common method which I call ‘organization-based budgeting’. I then describe three alternative approaches that I’ve seen used with some success. I call these ‘output-unit budgeting’, ‘outcomes-based budgeting’ and ‘activity-based budgeting’. I will also discuss the issue of cost structure and bargaining power since these concepts are relevant to this conversation.
This article assumes that you have researched current and historical costs, and that you know the levels of effort that your team needs to assign to the project.
2. Cost categories
Let’s start by looking at the cost structure of non-profit organizations and social enterprises.
In their income statements and expense reports, we will tend to observe the following categories of costs.
- Salaries of managers. This category includes the salaries of the executive director, operations manager, financial manager etc. Along with leading the organization, these staff may spend some of their time working on projects.
- Salaries of administrative staff. This category includes the salaries of the receptionist, bookkeeper, social media specialist etc. These staff spend the majority of their time on non-project activities.
- Salaries of project staff. This category includes the salaries of those staff who are involved in directly delivering in producing or delivering the goods or services of the organization. They include project managers, facilitators, counselors, social workers, health workers, project administrators, monitoring and evaluation specialists etc.
- Indirect costs. These are costs paid to external suppliers for goods and services that an organization needs to function. These costs are not project specific. Typical examples include audit fees, internet, stationary, rental, website, lawyers etc. These costs are sometimes referred to as ‘overheads’.
- Direct project costs. These are costs paid to external suppliers for goods and services that are integral to the project. These costs may include workshop venues, flights, catering, medical supplies etc.
The ratios between how much each category costs will differ between organizations and projects. There is no optimal formula or set of ratios, despite some donors wanting to cap the amount of funds going towards management salaries, administrative salaries and indirect costs at 10% of a project’s budget.
While donors are reluctant to pay for indirect costs and certain management and administrative salaries, they tend to be quite happy to pay for the salaries of project staff and direct project costs.
3. Four budgeting methods
Non-profit organizations and social enterprises tend to use one of four methods to develop project budgets in their funding proposals. I will cover each of these costing methods in turn.
3.1 Organization-based budgeting
This method is popular with non-profit organizations in South Africa and donors tend to be familiar with it.
With this method, an organization presents its donors with a portion of all the costs that are relevant to the proposed project. This may take the form of a percentage of each line item or type of cost that the project requires. Where an organization only has one project, then the costs of the organization will be equal to the costs of the project.
Then donors choose the line items, and the proportion of these line items, that they want to fund.
Where donors are picky and/or the organization has low bargaining power, this results in a project budget that is too low. The organization must then find the money elsewhere. They might decide to draw upon their unrestricted funding, or financial reserves, or other money in their bank accounts. However, all these tactics can create cash flow problems in the future.
I’ve seen so many of these problems occur. Donors pay too much attention to the cost structure of organizations. I’d prefer them to focus on how a project will achieve its impact and whether they are getting value-for-money. Skilled fundraisers are able to focus the conversation on this.
3.2 Output-unit budgeting
With this method, an organization identifies the key outputs of the proposed project. Outputs are the immediate result of the activity of an organization. They might include numbers such as the number of workshops or medical tests conducted or food parcels delivered. Outputs do not necessarily represent positive change in the world.
The organization must then work out the ‘full cost’ or ‘true cost’ to achieve these outputs. Even hidden costs like depreciation and finance charges are included. All organizational costs are appropriately apportioned to the project.
There are several approaches for apportioning overheads to a project. You might decide to apportion them based on the proportion of total income, or number of beneficiaries served or some measure of resource consumption.
The next step is to divide the true costs of a project by these key outputs. This will result in a unit cost. Examples of this include: the cost of each young offender to attend a diversion programme or the cost of each nutritious meal distributed to schools.
I also encourage you to look around your sector and find some benchmarks of how much organizations are charging for similar outputs.
Then consider whether it is appropriate to add a profit margin or surplus onto your unit costs. This surplus can help to build reserves and subsidize the costs of other activities. It will also help to manage project risks, especially if your organization will only receive final payment paid on delivery of these outputs.
When you engage with your donors around this budget, move the conversation away from costs. Focus rather on outputs and the impact of your organization. Show them what a good deal this is.
3.3. Outcomes-based budgeting
This method is similar to the previous method, but it is focused on the outcomes instead of outputs.
Outcomes are positive and intended changes in the world that are directly caused by the organization. This is the best measure of an organization’s effectiveness. Outcomes are not accidental by-products of activity.
The outcomes of non-profit organizations may include improvements in the knowledge, behaviour, health and circumstances of beneficiaries.
This is the most complex of the costing methods. It takes a lot of time and effort for an organization to identify an outcome that is meaningful and within its ability to achieve and measure.
Organizations must also overcome the ‘attribution problem’. This involves figuring out how much of its impact is as a direct result of its own actions. In other words, the organization’s impact cannot be as a result of external trends and policy or the actions of other organizations.
When applying this method, organizations must first identify the true cost of achieving their outcomes. This is then divided by the number of beneficiaries. For example, you could calculate a cost for each juvenile offender you rehabilitate. You could also calculate the cost of achieving a single outcome such as a shift in policy.
Then add an appropriate margin to the equation. This will help to manage risk and potentially bolster your financial reserves.
A final comment on this method. You may have heard of ‘social impact bonds’. This is an example of outcomes-based funding – contracting and funding the achievement of an agreed set of outcomes. For example, in 2018 the Western Cape Government entered into a social impact bond with Mothers to Mothers to help 3,000 children achieve certain health outcomes (e.g. weight, vaccinations) by a certain age.
3.4 Activity-based budgeting
This is the method that businesses tend to use when providing some sort of project management or consulting service.
It involves calculating a charge-out rate (e.g. R450/hour or R3,600/day) for each employee who is directly involved in the project.
The rate is based on the cost-to-company of each employee involved in the project. Non-profit organizations tend to multiply this rate by a factor of x3 or x4. Profit-driven businesses will tend to use a higher multiplier.
For example, let’s assume that the total cost (including allowances and benefits) of a project manager is R16,000/month based on 160 hours per month. Then his or her cost-to-company is R100/hour. This organization might charge this employee out at R300/hour or R2,400/day to a project.
The multiplier depends on an organization’s cost structure and business model. It should be enough to manage project risks and produce a financial surplus. You will need to do some careful calculations to determine the optimal multiplier. It is inaccurate to generalize across sectors and types of organizations.
The charge-out rate should also be comparable to what similar organizations are charging for the time of their employees. You must update this benchmark regularly.
This project budget will only include two types of costs. The first is the charge-out rates of employees who are directly involved in the project. The second are the direct costs paid to external suppliers (or even beneficiaries in the case of costs like stipends).
Its best to leave out indirect costs and the costs of employees who are indirectly involved in the project. The charge-out rates will absorb or cover these indirect costs.
This will result in a more action-orientated budget, which aligns with project activities.
4. Bargaining power with donors
Whether you realize it or not, your organization has bargaining power. This is its ability to negotiate a favourable arrangement with a supplier, customer, donor or partner.
The quality of your brand is central to your bargaining power. You can read about this in “brand is a magnet for opportunity.”
Your brand is what people sense or feel about your organization. A good brand enables people to recognize an organization within a crowded market. It creates trust that your organization is everything it claims to be and is able to deliver on its promises.
There are two other big contributors to an organization’s bargaining power. The first is its perceived ability to solve the problems that matter to your donor. The second is the number and strength of your competitors. If your organization is seen to be one of a select few that are capable of solving an urgent and important problem, then you have lots of bargaining power. The converse is also true.
When you have bargaining power, you will be more able to persuade some donors to accept a budget that is favourable to your organization. You will also have more discretion about which project budgeting method to use.
5. Cost structure and economies of scale
I’ve also written about why non-profit organizations should strive to “maintain a low fixed cost structure”. This will enable your organization to expand and contract depending on the availability of funds and number of projects.
This will make it easier for an organization to stay afloat and manage its cash flow. It will also make its budgets more competitive as they are not overloaded with a disproportionate share of overheads.
These four methods may not always suit your organization or project or donor.
But it’s good to have these methods in your toolkit, so as to be more prepared and versatile.
It takes time and effort to learn these methods of project budgeting. Get some expert advice if you feel you need it.
Before you prepare your next project budget, pause for a moment, and consider “what method should I use for this project and donor?” Some of your donors may be open to a different type of project budget.
Being more versatile will help your organization to manage risk and cover all project costs. It may even help to generate a surplus and strengthen financial reserves.