The government and the Compact recognises that:
- No activity can be undertaken without its provider incurring central administrative costs; [Note 1]
- Funders and commissioners have an interest in meeting their fair share of a provider’s central administrative costs because that will help to ensure that the provider can manage its activities and finances properly, and will contribute to the organisation’s sustainability.
This means that your programme must finance its ‘fair share’ of all providers’ administrative costs. This principle is known as ‘full cost recovery’. How this principle is applied differs between procurement and grantmaking. In addition, if the provider is a charity, you must not expect it to subsidise the cost of your programme from donations that it receives. [Note 2]
Under procurement, it is up to:
- The potential provider to bid at a price that it considers appropriate, taking account of all its costs
- You to accept (or not) that bid. In deciding this, you must consider whether the potential provider’s proposed price is sustainable. You cannot give preferential treatment to third sector organisations (TSOs). However, as part of good risk management, you must check that any award will provide the degree of continuity of service required by the objectives of the programme.
There are two possible scenarios under grant.
The first is the one in which your organisation wishes to give money to a TSO to contribute towards the TSO’s purpose. You must check that the proportion of the grant that will go towards administrative costs is reasonable and provides value for money.
The second is the one in which your organisation wishes to give a grant to a TSO for provision of a service. You and the provider must agree the full cost of the activities that the provider will carry out on your behalf and the proportion of those that will go towards administrative costs. Transparent costing, rather than pricing, based on a sound methodology, is the best way of ensuring this. Treasury guidance (pdf – 696KB) says that, when making grants, funders should assess in a simple, proportionate and equitable manner whether TSOs have allocated relevant overhead costs and ensure that costs are recovered only once.
Under grant-in-aid, your funding is not restricted to specific activities, so it can be harder to establish the correct amounts of funding needed, including full cost recovery. However, where the funding is intended, for example, to allow the TSO to develop its services in a way that requires taking on additional staff, you and the provider must ensure that the funding will be sufficient to cover at the very least the full costs of those staff and an appropriate share of administrative costs. Transparent costing, based on a sound methodology (rather than pricing) is the best way of ensuring this.
When a TSO delivers a service on behalf of a public body, that service will need to be managed, and that management will have to be financed. FCR is an acknowledgement that, if you fund a TSO to deliver a service, you must also fund your fair share of the management cost.
Calculating Full Cost Recovery
The common principle is to:
- Calculate the total management cost for the TSO, including elements such as governance, strategy and policy, human resources, finance and quality assurance;
- Apportion the total management costs across the TSO different programme’s of work in proportion to the size of each of those programmes.
In doing this, make sure that the apportioned costs are fair and reasonable. For example, a volunteer’s time should not be included but the cost of managing volunteers should be.
Putting it into practice
The methodology available for calculating the management cost varies between grants and procurement. In a grant process, you and the TSO apply the principle set out above working with openness and trust. This implies a relationship that is based on shared values. It often works well if both parties are open about finances.
The method in procurement is somewhat different. Here, the provider will bid at a price that it believes will win it the work. It is not your job to second guess the price offered, whether the bidder is from the private sector or a TSO. But you should check that the price offered is realistic and allows for proper administration and management of delivery. If not, the proposal may not be sustainable and you may be faced with dealing with a failure to deliver and the cost of another round of procurement. In the long run, better value for money may be gained from choosing an alternative provider that has more realistic costings.
There is one case where FCR is not an issue. If your public body makes a gift towards the cost of a TSO’s activities (typically in the form of a grant without significant conditions), that is analogous to you personally making a donation to a charity of your choice. You are not in that situation responsible for the cost of the TSO’s overheads.
Note 1: Also known as ‘management’ overhead.
Note 2: Charity Commission ruling (2004) – Applications for Registration of Trafford Community Leisure Trust and Wigan Leisure and Culture Trust.
This ruling says that where trustees contract to deliver services which a governmental authority is legally required to provide with no discretion over the level of provision, trustees should generally expect the governmental authority to meet the full cost.
In deciding whether to commit charitable funds to subsidise or enhance the level and standards of service over which a governmental authority has discretion over the level of provision, trustees should have regard to (i) the social and economic need for such service and its enhancement over and above that which the governmental authority would support, (ii) the effective use of the charity’s resources and (iii) the best interests of the charities beneficiaries.