How to Plan for a 5% Administrative Cost Cap at Your Nonprofit
In August, the U.S. Department of Health and Human Services proposed a rule to reduce the cap on Head Start administrative costs from 15% of total program costs to 5%. According to the agency’s own analysis, only 3.7% of Head Start grants currently operate at or below 5%.
The rule is not final and may change. The agency’s estimates assume a phase-in starting in 2027, and nothing takes effect until it publishes a final rule. But if your agency runs a Head Start program, one question is worth answering now: what would it take to get there? Any grant-funded nonprofit can use the same approach to manage its administrative rate.
We’re working through that question with a Head Start agency for which we run the finance function, and here is what we have learned.
The Cap May Drop, But the Work Doesn’t
The proposal leaves federal monitoring and audit requirements in place. Your finance office still owes the same obligations: federal financial reports, Form 990, an annual single audit by a CPA firm, grant draws that match payroll and payables, and regular reporting to your policy council, your board, and state and federal agencies. Grant accounting is budget-intensive and closely scrutinized. Someone still has to do it, and do it right.
Know Your Number Every Month
You can’t manage a percentage you only see at audit time. For our client, we run a year-to-date profit and loss statement by department and report administrative spending as a share of total expenditures in every monthly board package. They are at 9.8% today. That is comfortably under 15% and nearly double 5%.
If your accounting system can’t produce a P&L by department, it’s important to fix that first.
Look at What’s in the Administrative Line
At a smaller agency, the list is short: the executive director’s salary, the finance function, fringe benefits, rent, the audit, payroll processing, etc. For our client, reaching 5% means taking roughly $200,000 from a category that mostly covers the director and the accounting team. Smaller agencies feel this most because fixed costs are spread across fewer children.
Four Ways to Move the Number
Right-Size the Finance Function: when we started, we replaced a three-person department with part-time, on-site support, which saved the agency $30,000 to $40,000 in the first year; now that the systems are built, we are reducing our own hours and shifting data entry to a lower-cost clerical role, and we stay on the month-end close and reporting
Stop Doing Things Three Times: printing, signing, scanning, and uploading is the old way; monitors and auditors can review a well-organized shared folder without visiting your office
Review How Costs Are Coded: some costs sitting in administration may belong to a program, so it’s important to make those changes carefully, document them, and involve your CPA
Grow the Base: the cap is a percentage, so adding a service area or merging with a neighboring agency spreads the same overhead across more grant revenue
If the math still doesn’t add up, the proposal allows programs to apply for a waiver.
You Have Time, So Use It
Model the change during budget season. Build the budget by department and position, decide which changes to make and when, and present the plan to your board before a monitor brings the problem to you. Then track actual results against your budget each month.
How Wise Consulting Can Help
Our US-based, degreed accounting professionals serve as fractional controllers for grant-funded nonprofits. We handle grant draws, monthly board reporting, administrative cost monitoring, budgeting, and audit preparation, and we work alongside your CPA firm. When the financials are in order, the audit is easy.
Not sure where your administrative costs stand? Request a free financial diagnostic.
