Financial Management: Sustainability and Accountability – the Managing Think Tanks Series

6 May 2013

[Editor’s note: this chapter, while belonging to Raymond Struyk’s book Managing Think Tanks, was written by Jeffrey Telgarsky]

Think tanks are usually in a constant search for funding, particularly those in developing countries where local sources of funding are virtually nonexistent.  Thus, it is important for think tanks to have the technical qualities to be competitive in their market. This means that organisations have to show an understanding of its costs, and control of and accountability of its use of sponsor funding.

To understand its costs means that a think tank will be able to link the research it intends to do with the funding available from a sponsor. It also needs to demonstrate to sponsors that they are using the money for the purpose intended. Most developing country think tanks do not quite have a system in place that can meet these standards:

Most of them do not have a clear understanding of indirect costs. Their project budgets are either based solely on direct costs, which often means they are not truly including all the costs of the organization in their requests for funding, or they include an ad hoc factor for “overhead,” which is usually an arbitrary mark-up applied to total costs… As a result, these organizations seem to be constantly in a state of financial crisis, living from project to project with little financial stability for the organization or its staff.

Once think tanks begin to mature and develop into a larger organisation, several situations occur. For instance, there is greater formality in staffing arrangements; more substantial fixed costs related to facilities, such as equipment and maintenance, and administration; and greater costs for business development. These changes result in think tanks incurring costs that cannot be attributed to specific research projects (at least, not without great administrative difficulty): in order words, indirect costs.

Knowing the full cost of a research project (that is, including indirect costs) sets a baseline for financial analysis of the project and provides a basis for requesting reimbursements from sponsors for its full cost. It is important to be able to measure and include all of the necessary costs of the organisation into research projects, particularly when one considers that sponsors are reluctant to pay for indirect costs.

Given limited funds, the sponsor desires the greatest result for a given investment and therefore wishes to be assured that indirect costs are being limited to those reasonably necessary for the think tank to continue to survive and develop.

Think tanks who wish to ensure its future sustainability should develop a way to account for its indirect costs, serving two functions: providing an internal management tool for identifying and tracking costs that are crucial to the sustainability of the organisation; and providing a clear statement of indirect cost recovery policies, so that sponsors pay only for a fair share of the organisation’s necessary costs.

A way to do this is to develop a financial management system that segregates and tracks indirect costs against direct project costs. Additionally, think tanks have to include an annual external audit. The audit can confirm the application of indirect costs recovery projects, and the validity of direct project costs.

Methods for allocating indirect costs

The chapter focuses on two common methods for allocating indirect costs: case-by-case allocation and developing an indirect cost rate:

1. Case-by-case allocation

It determines a rate of actual usage for each activity in the organisation. Examples are keeping track of long distance telephone calls, using a log for photocopying, etc.

2. Indirect cost rate

This is a way to distribute indirect costs proportionately across an organisation’s activities or projects. An organisation’s costs have to be first divided into two groups: direct costs and indirect costs. The indirect costs are then aggregated into a pool which is allocated to project costs, in proportion to the ratio of indirect costs to direct costs.

This method has to have a set of documentation that can be provided to funders.

Financial audits

Finally, auditing, which is a process commonly conducted annually by an outside accountant, is useful in assessing the completeness and accuracy of an organisation’s financial information. It can be used by think tanks as a management tool, as it assures sponsors that the think tank has sound financial management.