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Full cost recovery remains an important principle for financial relationships between government and the third sector, but government departments have found difficulties in translating the principle into practice, according to a review published yesterday by the National Audit Office.

Yesterday’s review examines the progress made by central government departments in ensuring that, by April 2006, third sector organisations are fully paid for the services they deliver on behalf of the public funder. Overall policy responsibility for relationships between government and the sector rests with the Office of the Third Sector – part of the Cabinet Office- and HM Treasury; although individual departments are responsible for their own spending programmes.

The NAO found that although full cost recovery has been kept high on the policy agenda since 2002, a significant proportion of third sector organisations do not consider they are receiving full cost recovery, even though the target date has passed. The report found that few departments had made significant practical changes to funding practice in response to the target. However, departments generally felt the spirit of the target had been met.

The review concludes that full cost recovery is not a concept that public funders can implement or roll out in a mechanistic way. The concept does not necessarily apply in the same way across the variety of financial relationships between public funders and the sector. And the term has the potential to mislead participants into thinking that all costs will be recovered in all situations, risking an expectation gap persisting between funder and funded. The concept also fails to reflect some third sector organisations’ preparedness to share the costs and risks in ‘joint ventures’ with public bodies.

The NAO recommends that the Office of the Third Sector and HM Treasury develop more sophisticated statements on full cost recovery that reflect funders’ responsibilities for fair treatment and risk management. The NAO also sets out the need to acknowledge that departmental practice towards cost recovery will vary with the purpose of the funding and the environment it takes place in.

The review identifies government’s current initiative to support the training of 2,000 public sector commissioners working with the third sector as an opportunity to develop and promote further thinking around the practical application of full cost recovery. The review also provides a framework for government departments to use in reviewing their major programmes and funding streams, and recommends they develop more explicit judgements on the application of full cost recovery to each, to arrive at agreed and mutual expectations on the issue with third sector organisations.

“This excellent report takes us beyond the simple assertion that full cost recovery should be applied to all public funding for the voluntary and community sector (VCS). It is the first report I have read which identifies the distinctions between grants and contracts and explains the value of both types of funding. The report shows a real depth of understanding of the complexity of the issues involved.

“This report should be read by the leaders of local VCS organisations and by those in local government who decide funding policy and lead local strategic partnerships. It will help everyone involved in local partnerships to understand why grants for VCS organisations should be sustained as an essential part of the local funding mix”

“The issue of full cost recovery has been at the heart of debates around the relationship between the voluntary and public sector. This report is a very helpful contribution to that debate, and should help to translate the high level principle into practice. This is something that is urgently needed to ensure that the Government meets the commitments they made back in 2002.”

“The NAO report states clearly that no department has undertaken a proper review to ensure third sector organisations can achieve full cost recovery. Five years after the government made a firm commitment to the principle, this is truly staggering.

We now want to work with government on a radical overhaul of procurement, so that third sector organisations can secure fair prices for their work. Local authorities and primary care trusts must take into account the wider social benefits of commissioning through the third sector. Driving prices down to rock bottom levels will not secure real value for the public. For our part, leaders in the sector need to be tougher negotiators, and secure a better deal for the people they serve.”

1. Full cost recovery aims to ensure third sector organisations – including charities, voluntary and community organisations and social enterprises – receive payment for the full costs of services they deliver on behalf of public funders. This means securing payment for both the direct costs of service provision and any overhead costs legitimately incurred in support of the service. Failure to pay for the full costs could result in third sector organisations subsidising public services and eroding their charitable reserves. This can threaten value for money through short term risks to the quality and effectiveness of a service, and longer term risks to choice and competitiveness in public service markets if organisations collapse or withdraw due to financial difficulty.
   
2. NAO expects to publish two further reviews of the third sector’s relationship with government. One will examine how the third sector’s involvement in the delivery of public services has been affected by the introduction of Local Area Agreements, and a second looks at the public funding of large national charities.
   
   
3. Press notices and reports are available from the date of publication on the National Audit Office (NAO) website, which is at www.nao.org.uk . Hard copies can be obtained from The Stationery Office on 0845 702 3474.
   
   
4. The NAO employs some 850 staff and is totally independent of government. NAO has had a specialist team examining government policy on the third sector since 2005, when the Value for Money report Working with the Third Sector was published.