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Cost Management and Cost Restrictions in the Aid Sector

Even though there may exist a strong demand for your solution in the community, it may not translate into commercially effective demand, since the target impact segment may be unable to pay, and the user and buyer segments may be facing financial constraints (see Customer Segments). This makes it difficult to develop a viable revenue model to cover the full range of operating and management costs.1 (Learn more about hidden expenses in low-resource environments here.)

To strengthen the long-term sustainability of your business model, you should ensure your organization identifies and evaluates its costs and determines how best to manage them.

Case Study: Reassessing Costs to Find Efficiencies

When expanding to new countries, Esoko ran the numbers and realized that it was losing money. The old business model relied on a cadre of market enumerators that were expensive to hire, train, and manage. That had worked for Esoko in Ghana because there were donor funds to subsidize the losses, but it wasn’t a model that could scale. Esoko could have scrapped its plans for expansion, doubled down in Ghana, and sought additional donor funds, which would have been a safe path. Instead, it chose to disrupt the core operating model, embrace the uncertainty, and view this as an opportunity for innovation.

The first thing Esoko had to do was unlearn what it thought it knew about the business. It threw out the old financial model and carefully reassessed its costs to find efficiencies. Esoko listened to what the market research was saying, even when it challenged its assumptions. And it reexamined its pricing, marketing, and branding strategies. Esoko also needed to track its finances in more detail, including cash flow, cash burn rate, and profitability.

Sustainable growth meant that funding shortfalls could no longer be covered by personal loans from funders, as is often done by start-up companies. With more detailed and frequent data about its cash on hand, Esoko was able to cut down its cash burn rate by 70%. It did this by making informed decisions to cut loss-making programs and focusing its efforts on products with higher profitability.2

Taken from DIAL’s Beyond Scale

Different Types of Costs​

Direct costs are expenses that can be traced to a specific activity that is directly related to a specific product, service, or project.

Indirect costs are expenses that cannot be traced to your specific product, service, or project, but are needed for the general operation of your organization. They can be called overhead costs or the remaining costs once your direct costs are computed.

To understand direct and indirect costs when building a budget, consider the organization’s work on your product, service, or project. Define these as programs of activity. Within each program, work out which costs directly relate to delivering the activities. We define these as direct costs. Some are quite straightforward to interpret, e.g., the costs of employees working directly on impact or the cost of materials needed to create the impact. Others are not so clear, as they may look less related to impact or they may be shared across programs, such as rental costs for a project field office.

A counterfactual is helpful. Ask yourself the following: Would these costs occur if the programs didn’t happen? If so, they are likely to be direct costs. Or are they more like costs that are for keeping the organization going? In an extreme situation, would the organization still have to pay these costs if no programs were happening? If so, they are likely to be indirect costs.

Key Resources

Sometimes you can allocate these costs to a funder by using tools such as labor distribution reports and time-tracking sheets. And for most grants and contracts, there is often a percentage of the overall grant or contract that is also admissible to be used to cover indirect and overhead costs.

Unavoidable and Avoidable Costs​

Often, donors and other funders will not be able to fund all of the direct costs for your programs. Also, the percentage of indirect costs they are willing to provide may be much lower than the percentage you need.

To cope with this, it is important to know which costs can be put off or canceled and which have to be paid no matter what. Look at your costs again and split them into those that are avoidable and those that are unavoidable. Once this is known, you can prioritize looking for funding for the unavoidable costs.

There will be some judgment calls to make. Some costs are not completely unavoidable but may require additional costs or long lead-in times to avoid. Others may technically be avoidable in the short term, but may be necessary for strategic reasons further down the road. This analysis is, therefore, more art than science.

Some examples of unavoidable costs may include payroll costs for current staff, rent for current buildings, license fees for important software, and program costs that are already underway and can’t be stopped. Some avoidable costs may include new staff costs and extensions to programs that aren’t committed to.

Once this analysis is complete, it is worth looking again at the avoidable costs. If these are avoidable, are they truly needed? Can you get some quick cost efficiencies by not incurring them?

Case Study: Commercial Partners Setting Financial Milestones

Esoko’s business model is now in a state of constant iteration. In the past year, it has been deleted and restarted four or five times. Esoko approaches its business model with the mantra: “nothing is sacred.”

This process has strengthened the organization overall and informed the spin-off of a new start-up company, Tulaa, which offers an m-commerce platform to connect farmers to financing and inputs. To fund Tulaa’s growth, capital from a commercial investor was raised for the first time. Taking commercial investments has forced Esoko to be laser-focused on achieving profitability. This impacts every decision the company makes. For example, when deciding to add a call center to Tulaa, Esoko had to assess the costs it would add, determine the value it would bring to the service, and then find a way to balance the two.

Tulaa’s investors have set a series of milestones and routinely ask to see Esoko’s business plan, revenue projections, and break-even analysis. The next round of funding and the expansion of Tulaa will depend on performance against these milestones. It hasn’t been easy, but Esoko thinks Tulaa should be able to break even within two to three years.3

Taken from DIAL’s Beyond Scale

Funding Pipeline​

Once the organization understands its costs, it can match them to potential funding sources. A funding pipeline will help keep track of opportunities, their potential value, and how likely they are to come to fruition. Judgment is required, as the likelihoods are always subjective in nature. However, having a holistic picture of the opportunities you are pursuing helps prioritize the work needed to chase those that are key.

When thinking about managing costs, it is prudent to establish some triggers for making decisions regarding your costs based upon milestones in your funding pipeline. Trigger points could be setting a date for getting a purchase decision by a government ministry or U.N. agency, or it could be the outcome of a grant proposal submission. Planning what your actions will be based upon these triggers can help you proactively manage your costs and not be caught having to quickly react to events.

Key Financial Statements​

Setting up and reviewing your financial statements is important to evaluate your organization’s financial position and identify costs that may not provide value. The three reports most relevant to your organization are below.

Income and Expenditure Statement​

This statement (also referred to as profit and loss in the private sector and Statement of Financial Activities in some countries) summarizes your organization’s income and expenditure for a specific period, showing the change in net assets calculated as total revenue minus total expenses. Click here for a profit and loss projection template.

Balance Sheet​

This statement summarizes the financial position of your organization at a particular date. It shows what you own or expect to receive ("assets"), and what you owe or expect to pay out ("liabilities"). It is a snapshot in time of what cash you have and what has a likelihood of becoming cash in/out in the future. To learn more, refer to this balance sheet cheat sheet. For a balance sheet template, click here.

Cash Flow Statement​

Once you understand your organization’s likely funding, you can build the most important document—a cash flow statement. By looking at your likely income and costs periodically, you can project your likely cash balances.

The aim should be to keep this balance at least above zero, and preferably above the level of cash reserve desired. An organization will become insolvent if this turns negative and there is no hope of it returning to positive.

Ultimately, cash is king. Other accounting statements like the income and expenditure statement and balance sheet provide useful management information. However, it is critical to have a good cash flow forecast and someone who is assigned to monitor it. Also note that other reports may have accounting adjustments, such as accruals or depreciation, which could mask your true cash position. But, ultimately, your cash balance is the most important measure.

Effectively managing your cash flows is vital for the sustainability of your business model. This statement helps visualize how numbers on budget spreadsheets and financial reports translate into the reality of cash changing hands. Without a healthy cash flow, your organization cannot operate sustainably, as it will not be able to pay staff and critical suppliers.

A cash flow statement shows the movement of funds in and out of your organization in a given period. Organizations can use cash flow statements to help track their day-to-day liquidity (e.g., when the staff is paid, when a bill is due, or when the grant payment comes in), show changes in their assets and liabilities, and create cash flow projections in order to estimate their future cash flows. This is essential for the long-term sustainability of your organization. Use this cash flow projection template to get started.

Managing cash flow in the aid sector may not always be easy. Reasons for this include:

  • Grant or contract decisions can often have long wait times.
  • Initial payments may take a while to process.
  • Subsequent payments may be slow to arrive from when your organization reports achievements to when it receives payments.
  • If required to do work upfront, your organization may end up draining its cash flows.
  • If getting a follow-up decision, the gap between your organization’s first contract and the next one can take a long time, since it’s not always as simple as rolling a contract over.

Nonetheless, managing cash flow is very important. Here are some top tips for effective cash flow management:4

Top Tips
  1. Know how much is needed to break even: An organization generating enough cash to go over the breakeven point is doing something well. But an organization that is experiencing funding shortfalls must immediately address the issue.
  2. Have an emergency cash reserve: Cash reserves allow the organization some flexibility and security during hard times.
  3. Encourage early/easy payments: Set terms in writing so you aren’t chasing payments, and lay out when payments are due i.e., within 15 days, not 30.
  4. Assign someone to monitor the cash flow: Keep track of the numbers to determine whether your organization is going over or under the breakeven point.
  5. Delay or reduce costs: Cutting costs (e.g., by finding partners to share resources) is essential.
  6. Monitor your pipeline: Ensure you keep track of your funding pipeline, whether it is prospects for purchasing your solution or grants and contract opportunities, and track the likelihood and timing of them being realized.

Key Takeaways​

  1. Organizations should identify and evaluate their costs and determine how best to manage those costs as their digital solution scales.

  2. Preparing a budget to support and maintain the solution is vital.

  3. Financial statements should be evaluated to identify expenses that do not provide value to organizational activities.

  4. The key financial statements to consider are the income and expenditure statement, balance sheet, and cash flow statement.

  5. Managing cash flow is important for the success of your organization, but in the aid sector it may not be easy.

Complete the following in your Business Model Sustainability Canvas:
  • Identify the key cost drivers in your business model.
  1. Gray, I., Komuhangi, C., McClure, D., Tanner, L. (2019). “Business models for innovators working in crisis response and resilience building.” DEPP Innovation Labs.↩
  2. Beyond Scale, BM Business Module 2, DIAL, 69.↩
  3. Beyond Scale, BM Module 2, DIAL, 63.↩
  4. FreshBooks. “10 Cash Flow Management Tips to Grow Your Business.”↩