Risk is apparent in all features of a business, this was a key message that was addressed in our previous article ‘How to get comfortable with risk‘.
An important part of assessing risks is ensuring the information produced by your organisation regarding the financial performance of each service is clear and accurate. We have reviewed various financial reporting and costing methodologies as well as developed management and board reporting packs for NFP service providers. The common goal being to create efficient systems that will produce consistent, accurate and transparent financial information regarding the cost of service delivery.
We have listed below the most important factors that we feel need to be addressed to implement a robust and reliable costing methodology. The goal being to improve business unit reporting to produce accurate and transparent financial reports by location, division, service type or at the individual client level.
The key steps are:
- Review and update your chart of accounts
- Determine the business activities to be reported on
- Identify costs as either direct or indirect (shared) costs
- Determine the most accurate basis to allocate the shared costs
- Develop your financial reporting templates
- Assess the performance of your various activities and the level of administration costs against funding contracts and industry benchmarks
Firstly, start with the chart of accounts and clean out those that are redundant. This is a housekeeping exercise to ensure that your reporting will be relevant and in sync with the services your organisation provides.
Secondly, identify your most aggregated business units (e.g. funded programs, commercial businesses, social enterprises, fundraising, fee for service programs and administration) and allocate costs to each of these first as a priority. If there are further sub sets of the core services such as separate locations or specific funded programs, then these should also be identified and the associated revenues and costs pushed down from the main business unit.
From here, review your non-wage expenses and classify them as either direct costs (related to a specific business unit) or indirect costs (not allocable to a specific service or business unit and more in the nature of general overheads or shared costs) such as rent, insurance and office costs. The aim of this step is to directly allocate as much of the organisations costs as possible to specific activities. Direct costing improves transparency and reduces the effort required or risk involved in developing assumptions and methodologies to allocate costs. Review your staff list and classify your people costs as direct or indirect wages. In this case, direct wages are attributed to employees whose roles are specific to one or more business units, whereas indirect wages are usually attributed to employees in management or administration whose role spreads across the entire business. It is better to allocate costs directly, (even if spread between two business units) than to classify them as indirect and allocate them to all business units as this may distort the picture of true service level results.
For indirect cost wages and non-wages, identify the activity that drives these costs. Do the costs relate to space occupied, staff headcount and other activities or are they proportionate to revenue? It is important to allocate the expenses on a basis that that will provide the most accurate representation for the true cost of the service or activity.
After collating this information, prepare the profit and loss report at the most detailed level (divisional level) showing revenue less the direct cost less the share of indirect expenses. If there is a limit to the amount of indirect costs (often categorised as administration costs and set as a maximum percentage of funding), consider reporting an income item below the net profit line to recognise an in kind contribution or subsidy. This would need to be offset by an expense in another business unit. A good example of this would be commercial activities such as rental income or interest on invested cash that may be used to subsidise specific program costs.
From here, aggregate the results of the detailed divisional level back to the main business units to ensure all administration or other shared costs have been allocated.
A project to reassess and refine your costing processes and overall financial reporting systems is critical to create a reliable base from which to make both operational and strategic decisions.
With increasing pressure on service organisations to find efficiencies, undertaking a review of your costing processes and financial reporting in itself will in most cases identify efficiencies in administration systems and processes. It also has the potential to release valuable time that can be directed towards other tasks such as developing strategies aimed to improve operational and financial performance and analysing service outputs and related information.
For a no-obligation discussion about your circumstances, contact Mark O’Connor on 1800 988 522 or cnmail@cutcher.com.au