The ALS Association, seeking a cure through research for Lou Gehrig’s Disease, has absolutely gone viral with its “Ice Bucket Challenge.” Videos are all over social media and TV showing people from all walks of life dousing themselves with icy water to raise money for the cause.

The results are stunning, with close to $100 million being raised from this campaign, compared to the association’s total contributions of $37 million for all of last year.

As this challenge shows, social media has fundamentally changed the structure of fundraising and development activities for charitable organizations.

 This is, without question, a “tipping point” in the future of financial sustainability for nonprofit organizations that rely on charitable contributions.

I continue to believe that the three legs of the sustainable, fiscally viable, and successful nonprofit organization are as follows:

• Outstanding management and board leadership, resulting in exceptional service     quality and outcomes in fulfillment of agency missions.
• An exceptional staff with extensive support from volunteers.
• A consistent fundraising and development program focused on planned gifts, special branding events, and bequests from a broad constituency of supporters.

The Ice Bucket Challenge demonstrates that your fundraising and development efforts need to include a substantive social-media branding and solicitation component. The flip side of contributions received is whether or not your organization is adequately accumulating and allocating costs to your fundraising activities.

In addition, New York Gov. Andrew Cuomo issued his Executive Order No. 38 in 2012, placing a cap of 15 percent on administrative costs of state-contracted service providers. Fundraising and administrative costs are two of the three legs of the cost-accounting stool for every nonprofit organization. Both government and private-sector funders, including donors, are increasingly interested in being able to assess the efficiency of organizational programs, services, fundraising, and administrative infrastructure.

Prior to Cuomo’s executive order, the nonprofit sector had been somewhat insulated from the need for sophisticated cost-accounting systems, until now. It used to be that government and third-party funders of nonprofits were focused on paying for programs as opposed to buying specific services on a unit-cost basis. The continuing move away from program-service funding toward the need to answer the question, “What does the service cost?” has dramatically changed the expectation for your ability to demonstrate cost-effectiveness. Now, everyone wants to know what they are buying and how much they are paying, and whether the price to be paid is competitive.

Since the Industrial Revolution of the 19th Century, manufacturers have focused on cost accounting as a key ingredient to financial success. A century of experience with developing cost-accounting systems led to many different approaches to determining the cost of producing a product. The three most common approaches that were developed are known as “standard cost,” “job cost,” and “process cost” accounting systems.

For example, in the auto industry, the Ford accountants can tell you the cost of every part that is used in the production and assembly of an automobile. The same is true of most industries where manufacturing, production, construction, and assembly are appropriate descriptions of the business activity.

Services versus products
The nonprofit sector is different in that most often the nonprofit entity provides a service instead of a product. The service sector also offers a different set of issues for cost accounting, particularly with the need for increased fundraising activities to subsidize mission-based program services. The current environment represents a dramatic change from the historical expectation that nonprofits have not been required to have sophisticated cost accounting because of the wide variety of funding mechanisms used to pay for their services. As a result, pricing and charges for services, in many cases, vary based on who pays the bill.

One nonprofit program may consist of many individual services. However, payment for these services may come from funding sources on a basis that is not directly tied to actual services provided. For example, many government grants are not based on specific units of service provided.

Deficit funding of programs means just that. While deficit funding is used much less frequently, if the program generates a deficit, then the funding source pays some or all of the deficit amount.

What does this mean? Where are we going with this?

The nonprofit sector has arrived at a tipping point on cost accounting and administrative efficiency. Government funders and regulatory authorities are demanding accountability and cost justification on the basis of service units instead of total program costs. More funding sources are paying for services on a unit-cost basis instead of program or deficit-funding approach.

As a result, success in today’s nonprofit sector has been redefined. Competition and cost are the important elements for determining bottom-line success (e.g., managed-care contracting). The challenge is to accomplish this transformation while maintaining or improving the quality of the services provided.

Now that you have a sense for the problem, let’s talk about the solution. Whether you are a board member, volunteer, management, staff, or donor to a nonprofit, please consider the following suggestions for developing your own circumstances-specific solution.

• Complete a thorough needs assessment of the current accounting system. Does it provide you with the necessary management and cost information?
• Be prepared to develop a cost-accounting system that will allow you to price your services, not just programs or departments.
• Determine the need for re-engineering the traditional general-ledger accounting system to integrate it with the cost-accounting system.
• Develop internal capabilities necessary to implement activity-based costing (ABC), where appropriate, in the organization. With ABC, you can evaluate the true costs of service components within programs, thus ensuring that you make the right long-term decisions on whether to continue to provide certain services or programs.
• Be prepared for ever-increasing competition on price. There is an instructive lesson to be learned from the experience of the airline industry, the Big Three automakers, and the independent retailers. I believe that we are in the middle stages of what I refer to as the “Walmarting” of the tax-exempt sector. Fiscal pressures are driving collaborations, mergers, and acquisitions.
• Think like a manufacturer. Identify your fixed and variable-cost components. Management must agree on those cost elements that need to vary with volume of services provided.
• Make sure that you are compliant with the cost-reporting regulations of the funding sources — federal, state, and county. Medicare, Medicaid, grant makers, and our friends at the IRS should not be forgotten. You must play the “game” based on their rules and regulations.

Cuomo’s executive order is just one example of the expanding focus and scrutiny of administrative costs of nonprofits. In your cost accounting, be sure to properly identify and segregate administrative and fundraising costs from direct program costs. Make sure that your payroll system provides you with the appropriate level of sophistication to document an accurate distribution of staff labor efforts to program, administration, and fundraising efforts.

In most cases, time is of the essence. What may have developed in the manufacturing sector over a century ago is a necessity in the nonprofit sector today, tomorrow, or yesterday, depending on your situation. Fortunately, there are many resources available to move rapidly toward a cost-accounting solution that fits. At the same time, many nonprofit service sectors do not yet have software applications that provide the level of sophistication necessary. If this is your situation, you need to make cost accounting a priority.

There is a significant difference between cost reporting and cost accounting. To understand the difference puts you one step closer to the solution.

Remember, accurate cost information is power.

Gerald J. Archibald, CPA, is a partner in charge of the management advisory services at The Bonadio Group. Contact him at (585) 381-1000, or via email at garchibald@bonadio.com