Elegant Cost Centers

• April 3, 2019
• Curtis Klotz

In my previous blog, the first of CLA’s new Innovation in Nonprofit Finance series, I introduced the concept of elegant financial systems. In this follow up, I’ll share some of the elegance principles as they apply to accounting for the large-scale structures of your organization — your cost centers: locations, funds, departments, programs, and projects. In a few weeks, we’ll post a companion blog on this site that will outline practical ways to put these principles into action in accounting software. Subscribe here to be notified when we post.

It all starts with your mission

To build toward financial elegance, start with the broadest view of your organization and work inward. All nonprofits have a mission and a corresponding mission statement. The way your organization goes about its work, and the financial systems it sets up to support its work, should flow directly from that mission. Whether consciously or not, over time you have established organizational structures (and corresponding cost centers) that reflect the methods you’ve chosen and resources you’ve used to fulfill your mission.

Ideally, you have defined the structure of your organization in the most effective way possible. If not, you may want to reorganize the structure to more closely match the natural divisions and natural processes you use to get your work done. In order to apply elegance principles, ask yourself if these divisions or categories make sense. Do your cost centers define the largest, most organic categories into which your mission work naturally organizes itself?

How does your mission work naturally arrange itself?

For some nonprofits, your work may arrange itself by location — where the activity at each site or city or region is the most natural way to organize your work. For others, it makes sense to organize your cost centers around staff that have similar expertise: social workers or teachers or legal advocates. Sometimes the most natural division of your organization falls around different services provided: daycare, housing assistance, or English as a second language instruction.

When designing your accounting system, try to avoid the pitfall of allowing outside influences to define your organizational structure and cost centers. Too often, nonprofits feel pressure to organize their work and their accounting around particular grants or fundraising events. Focusing too narrowly on specific grants can lead to a proliferation of cost centers and to overly-complicated accounting systems. To resist defining your nonprofit by its grant sources, instead define your cost centers based on your mission. Ask these questions:

• Is this particular cost center (location, fund, department, program, project) absolutely necessary for us to manage our organization and make important strategic decisions?
• Is this particular cost center (location, fund, department, program, project) absolutely required by outside users of our financial and organizational data — donors, foundations, government agencies, regulatory agencies, nonprofit watchdogs, or community members?

Accounting systems should mirror your organizational structure

If you’re satisfied that your organizational structure effectively accomplishes your mission, then build your accounting system to mirror and support that structure. The elegance principles encourage you to keep the number of defined cost centers as few as possible, but you may, out of necessity, need to create sub-categories under certain departments or programs or funds. Each cost center or corresponding sub-category should help you capture necessary information about the staff time, resources, and organizational support required to complete a particular portion of your mission work.

Our next blog post in this series will offer some practical examples of how to set up cost centers that match the structures of your organization. We will also encourage you to create cost centers for administration (management and general) and fundraising, as well as a cost center for to-be-allocated revenue and expenses. One reason these additional cost centers are important is for reporting purposes. Both the IRS Form 990 and audited financial statements under new FASB standards require you to report expenses by function (program activities, management and general, and fundraising). 

Another reason for including cost centers for administration, fundraising, and allocations is to allow you to determine the full costs of your programs. Future blogs will include more on the importance of allocations within your accounting system. Thoroughly understanding and allocating shared program expenses is key to determining the full cost of each of your locations, funds, departments, programs, and projects. Knowing the full cost of each part of your organization allows you to think and act strategically when considering funding, resource use, and program effectiveness. Being able to properly allocate costs to your grants and contracts is another important way that an elegant financial system can help support your mission and financial success.

Next up, we’ll share how to put the principles laid out above into practice. Then a few weeks after that, we’ll return with a discussion of the principles behind an elegant chart of accounts. Please subscribe to our blog to receive notice of each new posting. Along with this series on elegant financial systems, watch for pieces on other nonprofit finance topics as well. Feel free to use the envelope icon below to email any nonprofit finance topics you’d like to see covered in the future.

Tags: functional expenses, nonprofit accounting, nonprofit accounting software, nonprofit accounting systems, nonprofit cost centers, nonprofit finance, Accounting, Finance departments, Nonprofit general, Operations | Comments Off on Elegant Cost Centers