Over the last decade it has gotten harder to understand and evaluate the indirect cost rates being applied to grants. Nonprofit leadership has struggled to keep up as the requirements and recommendations around indirect cost rate calculations have shifted and changed. And yet, this work remains critically important to the effective financial management of nonprofit organizations because without accounting for indirect costs correctly nonprofits cannot cover their overhead.
Unless the expense of overhead costs such as rent, utilities, technology, and payroll are recouped through funding, an organization cannot be fully compensated for what it costs to run the programs that they offer, jeopardizing their ability to offer not only those programs but maintain other vital initiatives in the community as well. Therefore, properly calculating indirect cost rates is a cornerstone of effective grant management for nonprofits.
Nonprofits should be aware of the nuances that are created by an increasingly complex funding landscape, especially when multiple funding sources are involved. This scenario requires additional diligence when foundation or philanthropic, federal and non-federal government funds are included in a nonprofit’s budget.
To give you some perspective and offer guidance in this area, we have put together a quick guide to indirect costs for nonprofits. This is not meant to constitute legal advice, nor does it replace working with an experienced nonprofit Chief Financial Officer (CFO) that can address your organization’s specific circumstances. However, it will provide you with a brief overview of what you need to know to understand and apply indirect cost rates in compliance with applicable regulatory bodies. Please also recognize that we will be omitting discussions around nuances that may only be applicable to certain kinds of grants or types of organizations to make this resource applicable to as many nonprofits as possible, which is another reason why it is advised that you work with a professional who can specifically address your organization’s unique position.
What are Indirect Cost Rates?
An Indirect Cost Rate (ICR) are federal standards and can either be standalone indirect cost rates that are determined by a specific organization or federally negotiated rates (also known as NICRA – Negotiated Indirect Cost Rate Agreements), which are rates that have been decided by federal agencies based on historical costs that serve as the predetermined rate for all applicable federal grants.
ICRs are a percentage applied to the direct costs of a project to cover overhead costs. Governmental agencies often call these “F&A Costs” (facilities and administrative costs) and define them as “Costs incurred for a common or joint purpose benefitting more than one cost objective” explaining that, “An indirect cost rate is simply a device for determining fairly and conveniently within the boundaries of sound administrative principles, what proportion of indirect cost each program should bear. An indirect cost rate is the ratio between the total indirect expenses and some direct cost base.” The US Department of Labor and US Agency of International Development have 41 and 65 pages, respectively, telling you everything you need to know about indirect costs, but we are going to distill it down significantly.
In general, somewhere around 10% is a fairly common ICR, but some funding sources have considerably higher ICRs. For instance, the MacArthur Foundation specifies a 29% ICR for their project grants. Always review the grant agreement for any specific instructions that may be included on how to calculate indirect costs!
Applying Allowable Costs
Only allowable costs can be included as part of an indirect cost rate calculation. Federal regulations and the terms of the specific grant will determine which types of costs are considered allowable. Once allowable costs have been identified, the ICR can be calculated by dividing allowable costs by total direct costs (or in some cases modified total direct costs).
It is important to understand which expenses are allocated costs and which are shared costs. Allocated costs are those that are tied directly to a specific program while shared costs, like the name would imply, are shared between programs or projects. Allocated costs will be assigned directly to their corresponding program while shared costs will be divided up between all programs that benefit from the incurring of that cost.
In some cases, an organization may actually be allowed to charge indirect costs to a grant by allocating their actual costs to improve cost calculation accuracy. While this is inconvenient to do (and may require specialized software to accomplish) it is usually allowed per the terms of the grant. Again, the grant agreement should specify whether this is an acceptable practice.
Using a De Minimis Rate
One simpler solution is to skip calculating an indirect cost rate altogether and instead use a “de minimis rate” for all federal funds. The de minimis rate as of October 1, 2023, is 10% of Modified Total Direct Costs (MTDC). The US Department of Housing and Urban Development defines what is included in MTDC and explains the protocols around documenting and using a de minimis rate in conjunction with grant funding. 10% is also the standard in other funding arenas as well.
Ensuring Compliance
For grant compliance, ensure your organization is abiding by all applicable federal, state, and local regulations. The US Environmental Protection Agency has a helpful resource on how to prepare an indirect cost rate proposal for a nonprofit organization, but even if you do not use a formal plan to guide your efforts, you will still need to be able to articulate how rates are being calculated and allocated to meet compliance requirements. If you are using cost pools (which are groups of expenses like “facilities” and “administration” that would fall under indirect costs) specify how these cost pools are contributing to your indirect cost calculation. Additionally, the right cost allocation method will need to be used when distributing indirect costs among specific projects or programs to ensure that this is being done reasonably and consistently across the organization.
Funders (regardless of affiliation) have differing definitions and descriptions of ICRs. Compliance strategies should be developed for each funding resource. Federal funding compliance is impacted by the Fairness Principal and must be applied across all programs.
This is a good time to evaluate all your grant agreements and costs. Financial reports should be reviewed to ensure that they are accurate! Remember, without accurate financial records your ICRs will not be correct either, jeopardizing your grant funding potential and overall financial stability. If you do not have the leadership in place to maintain and oversee accurate financial reporting, you may need to bring in the help of a nonprofit CFO consultant to ensure that the organization’s finances are timely and correct.
Seeking Professional Financial Advice
With everything that must be considered when calculating indirect costs for nonprofits, organizations should rely on an experienced CFO or executive-level financial consultant with deep knowledge of these types of nonprofit cost calculations to lead their grant management efforts. This type of nonprofit leader will have the expertise needed to make and document cost calculations based on historical data and current compliance needs and present them with the kind of transparency that grantors require. Additionally, a financial leader with nonprofit grant management expertise will also have the foresight to monitor and review indirect cost rates regularly, documenting any rate negotiations and modifications as they occur to assist with future funding efforts.
When you need knowledgeable nonprofit financial leadership, we have a team of highly experienced CFOs that can help! Our outsourced CFO consulting services are designed to support your organization with careful financial oversight to ensure you are using grant funds appropriately and providing adequate grant reporting. Find out more about our nonprofit CFO consulting services and how we can assist with funding, budgeting, and compliance. Contact us today for more information!
