If you resemble many nonprofit organizations, you manage several programs or departments. Each of these programs has a budget that must fit within the overall budget for your nonprofit organization.
Suppose that when your nonprofit organization begins, you offer only one program — an after-school center that provides tutoring and homework assistance for low-income children. The program really clicks, and more children begin showing up after school — some because they need tutors, but others because their parents work and the kids need a safe place to go. To serve these new participants, you add art classes and a sports program.
So now, instead of one program, you have three. Each has its own budgetary needs. A program coordinator trains and recruits the tutors and purchases books, notebooks, and school supplies. The art program requires an artist’s time, supplies, space for art making, and access to a kiln.
To offer a sports program, your agency rents the nearby gym, hires four coaches, employs a volunteer coordinator to recruit parents and other assistant coaches, and purchases equipment. The specific costs of a program — books, art supplies, coaches — are called its direct costs.
But each of the three programs also depends on materials and services provided by the people who work on behalf of the entire organization, such as the full-time executive director of your agency, the part-time development director, and the bookkeeper.
Each of the three after-school programs also uses the organization’s offices, utilities, telephones, and printed materials. The costs that the various programs share — such as the executive director’s salary, bookkeeping services, rent, and telephone bills — are called indirect costs. You can think of these shared costs as the glue that holds the nonprofit together.
When you prepare a program or department budget, you want to include both direct costs and indirect costs.
Direct costs are pretty straightforward. For example, you know what you have to pay your tutors per hour, and you know how many hours they work. But indirect costs can be sticky, and not because they’re the organizational glue. They’re sticky to deal with because determining how to divide them accurately among your organization’s activities is difficult.
Many grantmakers are reluctant to pay true indirect costs associated with programs, and, if your organization depends heavily on grants, that reluctance can put you in the awkward financial position of being able to pay for a famous basketball coach but not to turn on the lights in the gym.
When your organization is relatively small with just a few programs, you may be able to keep accurate records for how staff members spend their time, how many square feet in a building a program uses, and even how many office supplies each staff member checks out of the supply cabinet. Based on those records, you can fairly estimate your indirect costs.
As your organization grows in complexity and number of programs, you may compute indirect costs by using a formula you derive based on your direct costs. Here are some sample formulas and steps to derive them.
| First, add all your direct costs: | |
|---|---|
| Program | Direct Costs of Each Program |
| Tutoring and homework assistance | $46,000 |
| Arts and crafts | $60,000 |
| Athletics | $164,000 |
| Total direct costs: | $270,000 |
| Then compute the percentage of total direct costs that each program represents: | |
| Tutoring and homework assistance | $46,000 ÷ $270,000 = 17% |
| Arts and crafts | $60,000 ÷ $270,000 = 22% |
| Athletics | $164,000 ÷ $270,000 = 61% |
In many cases, you can reasonably assume that the indirect costs of a program correlate to its direct costs, or that a program that’s more expensive requires more oversight of staff and more use of office space. In the case of the after-school center, all the indirect costs — which include a salary for the director, a contracted bookkeeper, rent, utilities, telephones, and printing — total $130,500.
Using this figure, you can put together the direct and indirect costs into a true financial picture of each program by multiplying the $130,500 in indirect costs according to the percentages that were computed for direct costs. Here is the proposed allocation.
| Program | Formula | Indirect Cost Amount |
|---|---|---|
| Tutoring and homework assistance | $130,500 x 17% | $22,185 |
| Arts and crafts | $130,500 x 22% | $28,710 |
| Athletics | $130,500 x 61% | $79,605 |
Sometimes organizations write a project budget by identifying all the direct costs in detail and then showing the indirect costs as one lump sum at the bottom of the list of expenses. But some funding sources balk at paying for indirect costs when they’re presented this way. The funders want to know what actual expenses contribute to those indirect costs.
You should show the specific indirect costs item by item rather than lumping them all together. For the tutoring program, for example, you would show 17 percent of the executive director’s salary, 17 percent of the bookkeeper’s fees, and so on.