Full cost recovery: why funders won't pay what services actually cost

The debate in brief

Every charity that delivers services has overhead costs: management, finance, HR, IT, premises, insurance, governance. These costs are real, unavoidable, and directly enable the work funders are paying for. Yet most funders — and government in particular — systematically refuse to cover them. The result is that charities subsidise the delivery of publicly funded services from their own voluntary income and reserves, gradually eroding the financial foundations that keep them viable.

Quick takeaways

The arguments

The case for full cost recovery

The argument is straightforward. If a funder commissions a charity to deliver a service, the cost of that service is not just the frontline staff and materials. It includes a share of the charity's rent, utilities, finance team, IT systems, insurance, governance, and management time. These are not optional extras. They are the infrastructure that makes delivery possible. A funder that pays for the project but not the overhead is paying for the building but not the foundations.

ACEVO's Full Cost Recovery initiative, launched in 2002 and developed in partnership with the Treasury, established this principle clearly. The accompanying guidance, endorsed by HM Treasury and the Home Office, stated that grant-funded projects should recover the full costs of delivery, including a proportionate share of overhead. NPC's 2004 report, "Full Cost Recovery: A Guide and Toolkit for the UK Voluntary Sector," provided practical tools for charities to calculate and present their true costs. The report found that the majority of charities were not recovering their full costs, and that this was a systemic problem rather than an isolated negotiation failure.

The principle has never been seriously disputed. The problem is that it has never been consistently implemented.

The commissioning reality

Government contracts are the sharpest edge of the problem. Local authorities and central government departments commission charities to deliver services — homelessness support, mental health provision, drug and alcohol treatment, domestic abuse refuges, youth work — under contracts that frequently cap overhead recovery at arbitrary rates. Rates of 5-10% for management and administration are common in commissioning practice, when the true overhead proportion for many charities is 15-25% or higher.

The result is predictable. NCVO's research on the voluntary sector's relationship with the state has documented how charities delivering public services routinely absorb the difference between what contracts pay and what delivery actually costs. The subsidy comes from voluntary income — donations, legacies, fundraised income — that was given to the charity for its mission, not to underwrite public service contracts. Over time, this cross-subsidisation drains the reserves and financial resilience that charities need to survive. It also creates a perverse dynamic where the charities most committed to public service delivery are the most financially vulnerable.

The Charity Commission has noted that trustees have a legal duty to ensure their charity's resources are applied to its charitable purposes. Systematically subsidising government contracts from voluntary income raises legitimate governance questions about whether trustees are fulfilling this duty — or whether they have been placed in an impossible position by a commissioning system that depends on their willingness to absorb costs the state will not pay.

The funder perspective

Funders and commissioners have their own constraints. Local authority budgets have been cut by an estimated 40% in real terms since 2010, and commissioners are under intense pressure to deliver more for less. In competitive tendering, the contract often goes to the lowest bid — and charities that price in full overhead recovery risk being undercut by competitors, including private sector providers, who either accept lower margins or have different cost structures.

There is also a persistent cultural assumption that charities should be able to do things cheaply. The overhead ratio myth — the idea that a lower proportion of spending on administration indicates a more effective organisation — reinforces the expectation that charities will absorb overhead costs without complaint. Funders who push back on overhead rates often do so not out of malice but because they are operating within a system that treats charity infrastructure as a cost to be minimised rather than a capability to be invested in.

The evidence

The evidence base for full cost recovery is well established, if largely ignored in practice. NPC's 2004 report found that the majority of charities surveyed were not recovering their full overhead costs from funders, and that the shortfall was being met from unrestricted income. ACEVO's subsequent campaign, supported by HM Treasury guidance, led to some improvements in awareness but limited change in commissioning behaviour.

NCVO's annual Civil Society Almanac has tracked the voluntary sector's income from government over two decades. Government funding to charities peaked at approximately £18.5 billion in 2009-10 and has since fallen significantly, reaching £15.4 billion by 2019-20 — the lowest proportion of voluntary sector income since 2004-05. While headline figures have partially recovered since then, the terms on which that funding is provided have deteriorated. The shift from grants to contracts — documented by NCVO and others — has moved risk from the state to charities while simultaneously tightening the conditions under which money can be spent.

The Treasury Green Book, the UK government's guidance on appraisal and evaluation, explicitly recognises that grants should reflect the full economic cost of delivery, including indirect costs. Yet commissioning practice routinely departs from this guidance. A 2019 DCMS-commissioned study of the charity-state relationship found that many local authority commissioners were unaware of, or did not apply, full cost recovery principles when designing contracts.

Research from the Lloyds Bank Foundation has shown that small and medium-sized charities — those with income between £100,000 and £1 million — are disproportionately affected because they lack the scale to absorb overhead shortfalls and the negotiating power to push back on contract terms.

Current context

The full cost recovery problem has intensified since 2024. The employer National Insurance Contributions increase from April 2025 added an estimated £1.4 billion in costs across the charity sector, with no corresponding uplift in government contract values. Charities delivering public services under fixed-price contracts had no mechanism to pass these costs on and no choice but to absorb them.

Inflation in 2022-24 compounded the problem further. Many government contracts contain no inflation adjustment clause, or include uplifts well below actual cost increases. NCVO described 2025 as "the year of the big squeeze," with charities caught between rising costs, rising demand, and funding that was not keeping pace with either. The combination of employer NIC increases, inflationary pressure, and static contract values has made the cross-subsidisation model visibly unsustainable for a growing number of organisations.

ACEVO has continued to advocate for full cost recovery as a baseline principle, and the issue featured prominently in sector submissions to the 2025 Spending Review. Whether government commissioning practice will change remains to be seen.

Last updated: April 2026

What this means for charities

For charity leaders, the practical implications are clear. Every contract or grant that does not cover its full cost is being subsidised from somewhere. Trustees and finance teams need to know the true cost of delivery for every funded programme, including a defensible allocation of overhead, and they need to be transparent about the gap between what funders pay and what delivery actually costs.

Charities should present full cost budgets to funders as standard practice, not as an optional extra. NPC's toolkit remains a useful starting point, and NCVO provides guidance on overhead allocation methods. The conversation should not be apologetic. Overhead is not waste. It is the cost of doing the work properly.

There is also a collective dimension. Individual charities negotiating in isolation will always be weaker than a sector that speaks with a shared voice. ACEVO, NCVO, and Locality have all called for commissioning reform that embeds full cost recovery as a contractual requirement, not a discretionary allowance. Charities that participate in these campaigns — and that share their own data on the gap between contract income and delivery cost — strengthen the evidence base for change.

The alternative is a slow, invisible defunding of the sector's capacity, where charities hollow themselves out to deliver services the state has commissioned but will not properly pay for.

Common questions

What does full cost recovery mean?

Full cost recovery means that a grant or contract covers the total cost of delivering the funded work, including both the direct costs (staff time, materials, travel) and an appropriate share of indirect costs (rent, utilities, finance, IT, governance, management). It is the principle that funders should pay the true price of the services they commission, not just the visible frontline costs.

Why don't government contracts cover full costs?

Several factors contribute. Local authority budgets have been cut significantly since 2010, creating downward pressure on contract values. Competitive tendering rewards the lowest bid. Commissioning officers may not understand or apply full cost recovery principles. And there is a persistent cultural assumption that charities should absorb overhead costs as part of their charitable mission — an expectation not applied to private sector contractors delivering comparable services.

What is cross-subsidisation and why does it matter?

Cross-subsidisation occurs when a charity uses income from one source — typically voluntary donations, legacies, or unrestricted reserves — to cover costs that another funder should be paying. When a government contract pays 80% of the true delivery cost, the remaining 20% comes from somewhere. That somewhere is usually money given by the public for the charity's broader mission. Over time, this erodes reserves, reduces financial resilience, and diverts fundraised income away from its intended purpose.

Is the overhead ratio a useful measure?

No. The overhead ratio — the proportion of a charity's spending that goes to administration rather than direct service delivery — is widely regarded by sector experts as misleading. NCVO, NPC, and the Charity Commission have all cautioned against using it as a measure of effectiveness. A charity with low overheads may simply be underinvesting in the systems, governance, and infrastructure it needs to deliver well. The overhead ratio myth is closely connected to the full cost recovery problem: both rest on the assumption that overhead is waste rather than capability.

What guidance exists on full cost recovery?

HM Treasury's Green Book recognises that grants should cover full economic costs. ACEVO published full cost recovery guidance in partnership with the Treasury in the early 2000s. NPC's 2004 report and toolkit provided practical methods for calculating and presenting full costs. NCVO offers ongoing guidance on overhead allocation. Despite this body of guidance, implementation remains inconsistent, particularly in local authority commissioning.

Can charities refuse contracts that don't cover full costs?

In principle, yes — and some argue they should. Accepting contracts that require cross-subsidisation can compromise the charity's long-term sustainability and raise governance questions about the appropriate use of charitable funds. In practice, many charities feel they cannot refuse because doing so would leave vulnerable people without services. This is the core bind: the commissioning system depends on charities' unwillingness to walk away from the people they serve, even when the terms are financially damaging.

Key sources and further reading

• "Full Cost Recovery: A Guide and Toolkit for the UK Voluntary Sector" — New Philanthropy Capital (NPC), 2004. The landmark report that established the practical framework for full cost recovery, including tools for calculating true overhead costs.

• Full Cost Recovery Initiative — ACEVO, 2002 onwards. ACEVO's campaign to establish full cost recovery as a standard principle in government and funder commissioning, including guidance endorsed by HM Treasury.

• The Green Book: Central Government Guidance on Appraisal and Evaluation — HM Treasury, updated periodically. The UK government's own guidance, which recognises that grants should reflect the full economic cost of delivery including indirect costs.

• Civil Society Almanac — NCVO, annual. The primary source for data on the UK voluntary sector's income, expenditure, and funding sources, including trends in government funding to charities.

• The Road Ahead 2025 — NCVO, 2025. Annual sector outlook describing the financial pressures on charities from rising costs, employer NIC increases, and inadequate contract uplifts.

• "Navigating Storm Clouds" — Lloyds Bank Foundation, 2023. Research on how funding pressures disproportionately affect small and medium-sized charities, including analysis of overhead recovery gaps.

• Public Trust in Charities 2025 — Charity Commission for England and Wales, 2025. Research on public attitudes to charity spending, accountability, and the persistent influence of overhead ratio perceptions.

• "Why Restrict Grants?" Evidence Review — IVAR, March 2023. While focused on restricted vs unrestricted funding, directly relevant to the full cost recovery debate as many restricted grants do not allow overhead recovery.