Recovering Indirect Costs for Nonprofits

When It Matters

Indirect costs are the expenses of running a functioning organization that cannot be pinned to one specific project or program. Fiscal management, human resources, the annual audit and the IT systems that serve every program at once all fall here.

Compare that with a direct cost, an expense whose benefit can be traced to a single funding source or program. An indirect cost is a shared cost: nobody can say it belongs to one program, yet the organization cannot operate without it. Typical examples are a share of senior and accounting staff salaries, audit and accounting fees, general liability and directors-and-officers insurance, and board travel. "Overhead" is another word for indirect costs.

You need this when you build a project budget, when you read a grant agreement, and when a funder's overhead policy lands on your desk with a number lower than your real costs. You also need it if you pass money to local or national partners, because they face the same problem you do.

The stakes are not evenly spread. Low, fixed rates weigh most on smaller organizations. One source also finds they weigh on organizations led by or serving Black, Indigenous and other people of color. Smaller organizations often carry higher indirect costs relative to their budgets and have less unrestricted money to fall back on. Whatever the funder says, you should be able to state what your indirect costs are and how you arrived at the figure.

How It Works

Here are four ways funders handle indirect costs. The first two come from sources that describe one national government's system, so check your own government's rules before relying on them.

Negotiated rate agreement. In the national system the source describes, this is a formal agreement between a government funder and your organization that sets the rate you may use. Once agreed, it applies to all of that funder's later awards until the agreement is renewed. To begin, identify the government funder that provides the largest share of your funding from that source, since the rate is typically negotiated with that funder. Expect the application to ask for several documents: a statement of your cost policies, your audited accounts, a list of the awards you have received, and the workings behind your rate. The application usually asks for a final rate, calculated from the prior fiscal year's filings, and a provisional rate, based on the estimated budget for the coming year.
Default flat rate, often called de minimis. In that same national system, if you have no negotiated agreement, you may be able to use a default flat rate. In the source's 2025 update, that rate was 15 percent of modified total direct costs. Check the date on anything you read and confirm the current number with the funder. In that system, an organization receiving $35 million or more in a given funder's funding annually cannot use the flat rate and must negotiate and renew a rate every year. Other governments may set different rules or none at all.
Foundation-set minimums or caps. Some private foundations set their own rules. One applies a 25 percent minimum indirect cost rate to grantees with annual budgets under $5 million, and a 20 percent minimum for those with budgets between $5 million and $50 million.
Full cost recovery. Here the grant or service contract covers the full cost of the project, including its share of support costs, so you do not have to pay for support from other income. Not all funders cover support costs, and those that do may cap them as a percentage of total project cost, often below what you actually spend.

A negotiated rate does not make an award bigger. It only changes how the same award is split between direct and indirect costs.

If you are a subrecipient receiving all your government money through a pass-through organization, you generally cannot negotiate a rate directly with the original funder. You can elect the default flat rate or negotiate a rate with the pass-through entity.

Key Components

A defensible rate rests on documents, not estimates. Put these in place.

A written, approved cost allocation plan. It records your allocation methodology, so shared costs, direct and indirect, are spread across funding sources by a written rule and not case by case.
A defined indirect cost pool. This is the total of your indirect costs for the fiscal year, such as insurance, board travel and accounting fees. Shared and indirect costs are pooled, and at the end of each period the pool is distributed to funding sources using your chosen base.
A reasonable, consistent cost base. The base must be applied the same way each time and cannot rest on guesses or budgeted amounts. The most common choices are modified total direct costs, or salary totals counted either with or without the related benefit costs. Modified total direct costs is a subset of direct costs that leaves out certain categories, such as capital expenditures.
Correct coding of expenses. Costs fully attributable to one program are coded straight to that program. Only what is truly shared goes into the pool.
Time sheets that match the charges. Hours recorded on staff time sheets must agree with how those hours were charged to funding sources.
A review for unallowable items. Someone should check the pool before it is used. In one documented case, board meeting snacks and meals were booked into the pool and later disallowed.
A clear rule for partners. If you subgrant, decide in writing how indirect cost recovery is shared with local and national partners.

Best Practices

Calculate your actual rate before you apply. Divide your total pool of indirect costs for the fiscal year by your chosen direct cost base. Knowing the real figure shows you the gap between your costs and any funder's limit. Organizations often understate their true costs because they fear a higher rate will look inefficient.

Write and follow a cost allocation plan. Document how you pool shared costs and which base you use to distribute them. A consistent, written method is far easier to defend than a series of one-off decisions made while budgeting.

Decide deliberately when a cap is below your rate. Do not just absorb the loss. If you cannot get the full cost from funders, decide whether the work is still something you want to do. If you go ahead, you may need to cover the gap from reserves or unrestricted income, and if the gap is too big to carry safely, you can decline the work. One approach is to ask the funder whether the cap can move, bringing your calculation and your cost allocation plan to show how you reached your rate. Even full recovery on a project only covers costs already incurred. It does not build reserves, so be honest about how much gap you can survive.

Decide before you apply whether you need a negotiated rate. If you are eligible for the default flat rate, weigh it against the effort a negotiated proposal demands.

Share indirect cost recovery with partners deliberately. Policies vary widely. Some funders and intermediaries give a fixed percentage of project costs as an unrestricted contribution to overhead, with no reporting requirement attached. Others aim at "true cost" funding, meeting a partner's real overhead needs. Either way, the money lets partners invest in their own systems and capacity instead of underpaying staff or stretching their teams thin. In one documented case, the local partners' share of recovery rose from zero to about 27 percent over roughly two years, more than £21,000, while the international intermediary kept about 73 percent.

Keep your time sheets matched to your charges. Hours recorded on time sheets should agree with how those hours were charged to funding sources, since claims that do not match can be disallowed on audit.

Common Mistakes

Understating your costs to look efficient. A rate that is too low leaves a gap you may have to cover from unrestricted income or reserves. Present the true rate as the cost of delivering the work.

Letting unallowable items into the pool. In one case, food for board meetings was booked into the pool; auditors later disallowed it and the money had to be repaid. Keep the pool to real support costs.

Treating time sheets as paperwork. If recorded hours do not match how they were charged to funding sources, the claims can be disallowed on audit.

Underestimating what a negotiated rate takes. A proposal calls for extensive documentation, cost allocation plans and financial analysis, which can overwhelm smaller organizations with limited administrative capacity.

Assuming a local office can fix partner sharing alone. Some large intermediaries manage funding through headquarters, which keep the larger share of any recovery before passing the remainder to a local or national office. That office then has little to share with its own partners. Because the policy applies across every country office, one office can rarely change it alone. Raise it at headquarters level.

Example

A small NGO is preparing a proposal and wants to know its own rate. Finance adds up the indirect pool for the last fiscal year: a share of accounting salaries, general liability insurance, audit fees and IT system upkeep. The pool comes to $150,000. Direct costs for the year, the base, come to $1,000,000. Dividing the pool by the base gives 15 percent, so every dollar of direct cost carries 15 cents of indirect cost.

Now suppose a prospective funder states a cap below 15 percent. On a project with $100,000 in direct costs, the NGO's real rate calls for $15,000 in indirect costs, and the gap between that and the cap is what the NGO would have to find elsewhere. The finance manager writes that gap down as a specific number, which is easier to discuss than a general complaint about underfunding.

The manager then takes one approach. The NGO sends the funder its approved cost allocation plan and its audited financial statements to show the rate reflects real operating costs, and asks whether the cap can move. If the funder holds firm, the board looks at unrestricted reserves and decides whether the gap can be carried without risking core operations, or whether to decline the work.

The NGO knew its rate before the conversation, could show where the number came from, and asked for specific things.