Why Full Cost Recovery Matters

TL;DR Full cost recovery means funders covering the true cost of delivering a project, including a fair share of overheads like rent, finance, HR, IT, and management time. Most charities do not achieve it. The result is systematic underfunding of the infrastructure that keeps organisations functioning, which eventually degrades the quality of the work funders are paying for. This is one of the most important and most frustrating structural problems in the charity sector.

Why this matters

Every charity that delivers funded work faces the same problem. A funder offers £100,000 for a project. The direct costs of delivery, staff time on the project, materials, travel, are £85,000. But delivering that project also requires office space, a finance team to manage the grant, IT systems, insurance, HR support, and management oversight. Those overheads cost another £25,000.

The charity has two choices. It can submit an honest budget of £110,000 and risk being told it is too expensive. Or it can submit a budget of £100,000, absorb the £10,000 shortfall from its own reserves or unrestricted income, and hope it can make up the difference elsewhere.

Most charities choose the second option. They do this repeatedly, across multiple grants, year after year. The cumulative effect is that the organisation's core infrastructure is gradually hollowed out. Systems are not maintained. Staff are overworked. Governance becomes stretched. And eventually, the quality of delivery suffers.

This is what makes full cost recovery a structural issue rather than a budgeting problem. It is baked into the incentives of the funding system.

The 5 things to know

1. Full cost recovery is a principle, not a formula

Full cost recovery means that every funded project should contribute a fair proportion of the organisation's overheads. The principle is simple: if a project takes up 20% of an organisation's capacity, it should cover 20% of the organisation's overhead costs.

In practice, calculating this requires a cost allocation methodology. The most common approach assigns overheads to projects based on staff time, but other methods (based on income, floor space, or activity) exist. HMRC and the Charity Commission do not prescribe a single method, but they expect the approach to be reasonable and consistent.

The important point is that full cost recovery is not about inflating budgets. It is about honestly representing what things cost. A charity that cannot tell you its overhead rate probably cannot tell you whether its projects are sustainable either.

2. Funders create structural pressure to underprice

The incentive structure works against honest costing. In competitive funding rounds, cheaper applications look more efficient. Funders reviewing a stack of proposals will naturally gravitate towards the one that promises to deliver the same outcomes for less money. If one applicant includes 15% overheads and another includes 25%, the lower bid looks like better value, even if the higher bid is more honest.

This creates a race to the bottom. Charities learn that including realistic overhead costs reduces their chances of success. So they trim. They absorb costs. They cross-subsidise from unrestricted income. They describe core costs using language that sounds more palatable: "programme management" instead of "CEO time," "monitoring and evaluation" instead of "finance team."

According to ACF research, many funders have acknowledged this problem in principle but have been slow to change their practices. Some foundations now explicitly invite applicants to include full overheads. But the competitive dynamic persists across the sector.

3. The consequences of underfunding overheads are serious

When overheads are systematically underfunded, the effects accumulate:

• Staff burnout: People work harder to compensate for under-resourced systems. NCVO's workforce surveys consistently show that charity staff report higher stress and lower pay than comparable roles in other sectors.
• Governance risk: Boards cannot function properly when there is no administrative support, no reliable financial reporting, and no capacity for strategic planning.
• Digital poverty: IT systems are not maintained or upgraded. Data security suffers. Organisations still run on spreadsheets and personal email accounts because there was never funding for proper infrastructure.
• Inequality: Larger charities with diversified income can absorb overhead shortfalls more easily. Smaller organisations, particularly those led by marginalised communities, are hit hardest. This compounds existing inequalities in who gets funded and who survives.
• Quality decline: Eventually, the quality of frontline delivery suffers because the organisational infrastructure supporting it has been starved.

The bitter irony is that funders who refuse to pay overheads are undermining the very outcomes they are funding.

4. Full cost recovery is linked to restricted vs unrestricted income

The full cost recovery problem is inseparable from the balance between restricted and unrestricted income. Restricted grants can only be spent on specified activities. Unrestricted income can be spent wherever the organisation needs it most.

When funders provide restricted project grants without adequate overhead contributions, the shortfall must be covered by unrestricted income. This means that donations from the public, trading income, and any unrestricted grants are diverted from strategic priorities to subsidise funded projects.

The result is that charities with high proportions of restricted income are often the most financially precarious, despite appearing well-funded on paper. A charity with £2 million in restricted project grants but only £100,000 in unrestricted income is in a much more fragile position than a charity with £1 million in unrestricted donations.

For more on how restricted and unrestricted income work, see What is restricted vs unrestricted funding?.

5. The sector is slowly moving, but not fast enough

There has been genuine progress. ACF has promoted full cost recovery principles among its members. Several major foundations, including Esmee Fairbairn Foundation and Lloyds Bank Foundation, have moved towards more flexible, unrestricted funding. The Covid-19 pandemic accelerated this shift, as funders recognised that rigid project funding was incompatible with the reality of crisis response.

But progress is uneven. Government commissioning and contracting remains particularly poor at recognising overhead costs. Many smaller trusts still fund only direct project costs. And even funders that accept the principle of full cost recovery in theory may not reflect it in their application forms, budget templates, or assessment criteria.

HMRC's approach to VAT on charity activities adds another layer of complexity, making it harder for charities to calculate and recover true costs.

Common misunderstandings

"Full cost recovery means padding your budget." No. It means honestly including costs that are real and necessary. Finance staff, office rent, and IT systems are not luxuries. They are the infrastructure without which projects cannot be delivered.

"If a charity needs overhead funding, it is not efficient enough." This is the overhead myth in action. Every organisation in every sector has overheads. Businesses include overheads in their pricing as a matter of course. Only charities are expected to pretend their infrastructure costs do not exist. For more on why overhead ratios are a poor measure of effectiveness, see The overhead ratio myth.

"Funders should just give unrestricted grants instead." Unrestricted funding is valuable, but it is not the only solution. The point of full cost recovery is that even restricted project grants should include adequate overhead contributions. The two approaches are complementary, not alternatives.

"This is just a problem for small charities." Large charities face full cost recovery challenges too, particularly in government contracting. But the consequences are more severe for smaller organisations with thinner reserves and less diversified income.

How it works in practice

Here is how full cost recovery should work, using a simplified example:

1. Calculate total overheads: An organisation adds up all its non-project costs for the year: rent (£40,000), finance team (£35,000), IT (£15,000), HR (£10,000), CEO time on governance and management (£30,000), insurance and professional fees (£10,000). Total overheads: £140,000.
2. Determine allocation basis: The organisation decides to allocate overheads based on staff time. The proposed project will employ two full-time staff out of a total team of ten. That is 20% of staff capacity.
3. Calculate overhead contribution: 20% of £140,000 = £28,000.
4. Build the project budget: Direct project costs (£85,000) plus overhead contribution (£28,000) = total project cost of £113,000.
5. Apply to funder: The organisation submits a budget of £113,000 with a clear explanation of how overheads have been calculated.

In practice, many funders will negotiate this figure down, cap overhead contributions at arbitrary percentages, or simply not fund overheads at all. The charity then has to decide whether to accept the grant on those terms and absorb the shortfall.

What people disagree about

The biggest disagreement is about whose responsibility this is. Funders say charities need to be better at calculating and communicating their true costs. Charities say funders need to stop penalising honest budgets. Both are right, but the power imbalance means the burden of change falls more heavily on funders. See Power dynamics in grantmaking for more on this dynamic.

There is also disagreement about what counts as a reasonable overhead rate. Some funders cap overhead contributions at 10-15%. Others accept 20-25%. There is no objectively correct number, because it depends on the organisation's size, structure, and activities. The push for arbitrary caps reflects discomfort with overhead costs rather than any principled analysis.

Finally, there is a deeper debate about whether project funding itself is the problem. If funders gave more unrestricted grants, the full cost recovery question would matter less. Some argue that the entire project-funding model is structurally flawed and should be replaced by trust-based, unrestricted giving. Others argue that project funding serves legitimate accountability purposes and just needs to be done properly. For more on this, see The full cost recovery debate and Why core costs are always political.

What to read next

• Why core costs are always political
• How trusts and foundations fit into the system
• What is restricted vs unrestricted funding?

FAQs

What overhead rate should I include in grant applications?

There is no single correct answer. Calculate your actual overhead rate using a reasonable cost allocation method, and include that figure. If a funder caps overheads at a lower percentage, you need to decide whether to accept the shortfall or negotiate. As a benchmark, NCVO and ACF have suggested that overhead rates of 15-25% are common and reasonable for most charities, but your actual figure may be higher or lower.

Do government contracts allow full cost recovery?

In theory, yes. Government procurement guidance acknowledges that contractors should be able to recover reasonable overheads. In practice, competitive tendering drives prices down, and charities frequently win contracts at rates that do not cover their true costs. This is a particularly acute problem in social care, where charities have historically absorbed significant overhead shortfalls on government-funded work.

Is full cost recovery the same as unrestricted funding?

No. Full cost recovery means that a restricted project grant includes an adequate contribution to overheads. The grant is still restricted to the project, but the budget recognises that delivering the project has indirect costs. Unrestricted funding, by contrast, can be spent on anything the organisation needs. Both address the same underlying problem, organisational sustainability, but through different mechanisms.

What should I do if a funder refuses to fund overheads?

You have three options: decline the grant, accept it and absorb the shortfall, or negotiate. If you accept and absorb, be clear-eyed about where the subsidy is coming from and whether your organisation can sustain it. If multiple funders are all underfunding overheads, the cumulative shortfall can become existential. Track it, report it to your board, and factor it into your fundraising strategy.