March 24, 2022

Media Release: Paying what it takes: report warns many funders failing to cover not-for-profits’ actual costs

Australian charities are being hamstrung by a lack of funding for their core operational needs, severely affecting their ability to deliver frontline services to Australians living with disadvantage.

A new report by the Centre for Social Impact and Social Ventures Australia has found that the prevailing funding model for not-for-profits is failing to cover indirect operating costs, threatening capability and effectiveness across the sector.

The research, supported by the Paul Ramsay Foundation and Origin Energy Foundation, found that indirect costs – such as IT, finance and human resources – comprised an average 33 per cent of the total cost of running a not-for-profit enterprise. However, funding agreements typically accounted for indirect costs of just 10 to 20 per cent.

The ‘Paying what it takes’ report has warned that Australian charities – already vulnerable in the wake of the COVID-19 pandemic – were at risk of being locked into a “starvation cycle”.

It has recommended a range of actions, including calling for philanthropic and government funders to offer full-cost funding to ensure not-for-profit organisations can maximise their impact.

Paul Ramsay Foundation Chief Alliances Officer Kristy Muir said the report tackled several common misconceptions about not-for-profits, including the notion that charities should spend as little as possible on indirect costs, also known as overheads, in order to not detract from their projects or programs.

“Research has shown that not-for-profits that spend less on indirect costs are not necessarily more efficient nor more effective than those who do not,” Professor Muir said.

“However, a significant proportion of Australian funders, both philanthropic and government, only fund a specific percentage of indirect costs or still use indirect costs as a way to differentiate not-for-profits.”

Professor Muir warned that this approach contributed to the “non-profit starvation cycle”, whereby inaccurate expectations of how much overhead was needed to run a not-for-profit meant that charities underreport their costs to funders.

“This leads to a sector starved of the necessary core funding required to create resilient charities delivering long-term impact on complex social issues,” she said.

A ‘pay-what-it-takes’ approach to philanthropy – ensuring a grant making approach that provides enough money for non-profits to pay for all their operations, not just programs and services – was first proposed in the US in 2009.

In Australia, conversations around indirect cost funding for not-for-profits have been gathering pace, however the pandemic, and the resulting financial uncertainty it created, was a catalyst for key organisations and funders to examine the issue in local context.

Origin Energy Foundation’s Sean Barrett said the report was a catalyst for a potentially game-changing discussion.

“Changing public perceptions is the first challenge. Because funding and donations are often directed at front-line service delivery, there is a perception that money spent on necessary expenses is wasteful,” he said.

“Challenge two is for funders and governments alike to acknowledge that not-for-profits need appropriate funding and support to run their organisations to be able to carry out their crucial work in the community.”

The Smith Family’s Chief Executive Officer Doug Taylor welcomed the report, saying it helped funders understand the real costs of making an impact and creating sustainable not-for-profit organisations.

“In the quarter of a century I’ve worked in the not-for-profit sector, I have seen first-hand what can happen when funders don’t cover all the costs of these organisations,” Mr Taylor said.

“When charities are forced to cut corners or burden frontline staff with additional admin work or forever chase new sources of funding, this threatens their ability to make a real and lasting impact for the people who need it most.”

Philanthropy Australia Chief Executive Jack Heath said best practice in Australia was starting to change, as foundations including the Myer Foundation, the CAGES Foundation, the Paul Ramsay Foundation and Origin Energy Foundation implement some form of full-cost or untied funding.

“This report is just the start of an exciting ongoing program of work,” he said.

“Philanthropy Australia will be hosting workshops throughout the year with the aim of building a coalition of leaders in philanthropy and the charity sector to determine the best path forward.”

Paul Ramsay Foundation Director Ilana Atlas AO said the foundation was adopting an interim 30 per cent for indirect costs across grants, with flexibility to shift lower or higher where rationale is shown, while also building capability to support the real direct and indirect costs of our partners.

“This is a critical move for signalling support for not-for-profits, which provide the services that people, communities and governments rely on,” Ms Atlas said.

“All not-for-profits and charities have indirect costs and funders need to work alongside them to work out what those costs are so they can achieve their full capability.

“Both funders and not-for-profits should be encouraged to have an open, productive dialogue around the true costs of any proposed programs or initiatives.”

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