Balance Sheet

Income Statement

Statement of Cash Flows

C H A P T E R

11 Setting Fees Fee setting can be operationally defined as the process of determining how much an agency will charge for its products and services. Fees are usually established in one of two ways. A fee can be set on a per output (or unit-of-service) basis, or else on a per client or per participant basis. Whereas cost accounting standards and guide- lines exist for the purposes of determining the full cost, or total cost, of a human service program (a major ongoing agency activity) or other agency activity (e.g., training program, workshop, seminar, special events), no comparable standards or guidelines exist for setting fees. Consequently, fee setting is as much an art as it is a science. The process of fee setting requires that human service administrators apply a variety of financial management concepts and techniques, as well as pro- fessional judgment, to determine a fee or fees that best serve the interests of clients, participants, the program or activity, and the agency.

A fee can be equal to, greater than, or less than the full cost of a human service program or other agency activity. For example, if a human service program is a rev- enue center, its fee might be set equal to its full cost. However, if the program is a profit center, its fee would probably be greater than the full cost. If a human service program or other agency activity uses variable fees or a sliding fee scale based on the economic circumstances of clients or participants, the fees paid by at least some clients will be less than the full cost.

This chapter discusses several major fee setting issues that human service administrators routinely consider when setting fees for programs and other agency activities. A case example (a child and family benefits seminar) is then used to demonstrate how these various fee setting issues might be dealt with. Again, the point is stressed that no hard and fast rules exist for fee setting. Rather, fees are arrived at on the basis of the financial analysis and the informed judgment of human service administrators.

Some Major Fee-Setting Issues

Figure 11.1 highlights some of the major issues that human service administrators consider when setting fees for human service programs and other agency activi- ties. Some of these issues (direct and indirect costs, fixed and variable costs, and break-even points) have already been discussed in previous chapters. Other issues

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are introduced here for the first time. They include depreciation and use allowance, unallowable costs, profit margins, market prices, and sliding fee schedules. Not all of these issues will apply to every fee setting situation. Nevertheless, many human service administrators ensure that they at least consider each of these issues to pre- clude errors of omission from occurring. In the following sections, each of these major issues is discussed in detail.

Direct and Indirect Costs

A good place to begin the discussion of fee setting is by ensuring that the full cost of any human service program or other agency activity has been identified. As dis- cussed in Chapter 8, the full cost or total cost of a program or other agency activity is the sum of its direct costs plus a reasonable proportional (allocated) share of indi- rect (overhead) costs. When an agency initiates, reduces, or terminates a human service program, indirect costs are routinely reallocated. Often, however, no indi- rect costs are allocated to other agency activities (e.g., one-day training sessions, workshops, seminars, special events). As a general rule, all agency activities (major and minor) should usually be assigned at least some indirect costs.

One reason frequently given for why human service agencies do not include indirect costs in computing the full cost of minor agency activities is that the effort involved is not worth the return. This need not be the case. Let’s assume, for exam- ple, that a human service agency has a total fiscal year operating budget of $2 mil- lion of which $1,750,000 is total direct (program) costs and $250,000 is indirect (overhead) costs. The agency’s indirect cost rate (using total direct costs as the base) is 14.3 percent. The human service agency decides to conduct a one-day workshop with direct costs of $10,000. How can one quickly and simply determine what amount of indirect costs should be allocated to the proposed workshop? Why not $1,430, which is 14.3 percent of $10,000? Using this simple approach, a human service agency can ensure that it takes full advantage of all opportunities to recover indirect costs. There is, of course, the possibility that a human service agency using this approach could “overrecover” indirect costs. If such a situation occurs, the accountants and auditors can sort things out at the end of the fiscal year.

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FIGURE 11.1 Major Fee-Setting Issues

1. Direct and indirect costs 2. Depreciation and use allowance 3. Unallowable costs 4. Profit margins 5. Fixed and variable costs 6. Break-even points 7. Market prices 8. Variable fee and sliding fee schedules

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Depreciation and Use Allowance

Facility and equipment assets used in the provision of human service programs and other agency activities break, run down, wear out, and eventually have to be repaired or replaced. In order to have sufficient funds available for the rehabilita- tion of facilities and the repair or replacement of equipment, these assets are fre- quently depreciated or a use allowance is computed.

Under the concept of depreciation, both the cost of an asset and its useful life are computed. Dividing the cost of the asset by its useful life generates a figure (a dollar amount) that represents the depreciation of that asset for one fiscal year. A portion of the annual depreciation is then included as a cost to all human service programs and other agency activities that benefit from the use of the asset. Some- times, however, a human service agency does not have a formal depreciation schedule on its facilities and equipment. In such instances, a use allowance can be computed in lieu of depreciation. A use allowance is simply some defensible cost that is charged to a human service program or other agency activity for “the use” of a facility or piece of equipment. Under the use allowance approach, the fair mar- ket rent on a comparable facility or a comparable piece of equipment is first com- puted. The resulting dollar amount is then apportioned between a human service agency’s programs and other agency activities according to how much use each makes of the asset. For example, if the fair market rent for a photocopy machine is $600 per month and the machine is equally shared by three human service pro- grams, then a $200 use allowance per month would be charged to each program.

If depreciation or use allowance is computed and included as part of a human service agency’s cost allocation plan, it should not, of course, be added in a second time. The concepts of depreciation and use allowance are both recognized and recoverable under most federal contracts, grants, and cooperative agreements (see Chapter 12).

Unallowable Costs

Unallowable costs are any items of cost that a funding source will not pay for or reimburse. For example, some private foundations restrict the extent to which their grants funds can be used to purchase equipment. The federal government and many state and local governments also identify specific items of cost that they con- sider unallowable (e.g., lobbying costs) for which they will neither pay nor reim- burse. Chapter 15, dealing with audits and auditing, provides a more in-depth treatment of the topic of unallowable costs and how human service administrators can identify them.

The problem with unallowable costs is that they frequently need to be excluded from the computations when determining fees for human service pro- grams or other agency activities. If a government or a foundation is going to be charged the fee and the computational base of the fee includes unallowable costs, a human service agency or program is exposing itself to a potential audit exception. If no government or private foundation will be charged the fee, then this issue is moot.

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Unallowable costs should be excluded early in the fee setting process so that they do not affect the determination of fixed and variable costs and the computa- tions involved in determining break-even points (BEPs).

Profit Margins

Before computing break-even points, the issue of including a profit margin should be considered. For our purposes here, a profit margin will be operationally defined as some additional increment over and above the full cost or total cost of a human service program or other agency activity. Defined in this way, several arguments can be put forward on the advisability of including a profit margin when setting a fee for a human service program or other agency activity:

■ The inclusion of a profit margin is necessary if the human service program is designated as a profit center.

■ Many one-time activities, although not designated as profit centers, are actu- ally designed to generate excess revenues to help support other agency pro- grams. For example, training sessions and workshops frequently have two purposes: imparting valuable information to trainees and participants and generating excess revenues for the agency. If a profit margin is not included in the fee charged to trainees and workshop participants, revenues cannot exceed costs and no excess revenues can be generated.

■ Flexibility in fee setting is frequently desired. This flexibility can take a vari- ety of forms including reduced fees, sliding fee schedules, or fee waivers for certain types of individuals or groups (e.g., low-income people). In order to break even, some profit margin must be included in the fee to be charged full- pay clients and participants in order to offset the loss of revenue for clients and participants that are charged a reduced fee or no fee.

■ The setting of any fee is at best an educated guess. Uncontrollable variables can work against a fee actually generating revenues sufficient to cover expenses. For example, variable costs can be underestimated or demand for the program or activity can be overestimated. The inclusion of a profit mar- gin provides a contingency or cushion against the effects of uncontrollable variables.

What should be the size of a profit margin? No hard and fast rule exists, but a figure of 2 to 5 percent is frequently used in the private nonprofit sector. In terms of computing the profit margin, the full cost of the program or activity becomes the base. Two to 5 percent of the base is computed and the resulting amount is then added to the base.

Fixed and Variable Costs

Another major issue in fee setting is the identification of fixed costs and variable costs. Fixed and variable costs were discussed at length in Chapter 10. The focus of

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Chapter 10, however, was on understanding the differences between fixed and variable costs and how they are used in break-even analysis and decrease/discon- tinue decisions. The identification of fixed and variable costs is also an important issue in fee setting.

As discussed in Chapter 10, the total variable costs of a human service pro- gram or other agency activity depends upon the amount of service provided (i.e., the number of outputs or units of service provided or the number of clients or par- ticipants served). For example, workshops, seminars, and special events frequently include participant workbooks and handouts and may also include coffee breaks, lunch, and so on. The total cost of these items will vary depending upon how many people participate. Consequently, fixed and variable costs must be identified and one or more BEPs computed assuming various levels of service output (or units of service), clients, or participants.

Break-Even Points

Break-even points are yet another important consideration in fee setting. Different BEPs have different associated fees. In general, lower BEPs result in higher fees, whereas higher BEPs result in lower fees. Two factors that affect BEPs are capacity issues and go/no-go decisions.

Frequently, the size of a facility, equipment availability (e.g., computer work- stations), or some other “capacity” factor will determine the maximum number of outputs (or units of service) that can be provided or the maximum number of clients or participants that can be served. Capacity issues are directly related to the computation of break-even points. If an individual BEP is greater than the capacity of a facility or is greater than the availability of equipment, it represents a solution that is outside the feasible range.

Go/no-go decisions usually apply to one-time agency activities (e.g., training sessions, workshops, seminars, special events) and are concerned with establish- ing cutoff points, which are guaranteed minimum numbers of outputs (or units of service), clients, or participants without which the program or activity will be can- celed. Like most of the issues involved in fee setting, no hard and fast rules exist to aid in determining a cutoff point. The establishment of a cutoff point has a lot to do with how much risk a human service agency is willing to assume and how impor- tant the activity is to clients, participants, or the community.

Frequently, a cutoff point and the break-even point are one and the same. For example, training organizations frequently set their combined go/no-go decision points and break-even points at relatively low levels. For example, take the case of a seminar that can accommodate a maximum of 40 participants. The agency con- ducting the seminar might set its combined go/no-go decision point and BEP at 25 participants. If fewer than 25 participants register, the seminar will be canceled because otherwise the agency would lose money. If exactly 25 participants register, the seminar will be held because it will at least break even (including possibly a 2 to 5 percent profit margin). And if more than 25 participants register, the agency will make a larger profit because fixed costs will already be covered.

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Market Prices

The going market price per output (or unit of service) or per client or participant can represent a constraint on the fee that can be set for a human service program or other agency activity. For example, if the going rate for a home-delivered meal in a particular community is $5 to $6 and a human service agency proposes to set a fee at $7.50 for its home-delivered meals, it may well price itself out of the market. Governments as well as individuals and family members might not be willing to pay a $7.50 fee per home-delivered meal if they can get a comparable meal from another agency for $5 to $6. Likewise, if an agency decides to set a fee of $250 for a training session or workshop, when comparable training sessions and workshops in the community are priced between $100 and $125, no one may register.

When all the other fee setting issues just mentioned have been considered and when a proposed fee has been set for a human service program or other agency activity, the fee then needs to be compared with market prices. If the proposed fee is significantly higher than the market price in the community, then the fee may need to be adjusted downwards if possible.

Variable Fee and Sliding Fee Schedules

The final major fee setting issue to be discussed is that of variable fees and sliding fee schedules. Rather than having one fee that applies to all clients and participants regardless of economic circumstances and ability to pay, many human service agencies and programs prefer to establish variable fees or sliding fee schedules.

When considering variable fees or sliding fee schedules, it is important for human service administrators to keep in mind their effect on revenues. As an exam- ple, let’s say that the full cost of a program is $150,000 and that demand for the pro- gram is estimated at 15,000 outputs or units of service. The minimum fee must be $10 in order for the program to break even (to generate revenues equal to expenses). A decision to offer a variable fee or sliding fee schedule means that revenues will not equal expenses, unless some clients and participants are charged a higher fee to offset the lower fee charged to other clients. It is a basic economic fact that in order for some clients and participants to pay a lower fee or no fee at all, other clients and participants must pay more. Of course, some additional funding source might be found to make up the loss of revenue associated with the use of variable fees or slid- ing fee schedules. The effect of variable fees and sliding fee schedules on revenues may seem obvious, but it is an issue that is all too frequently overlooked.

Let’s now look at an example of the application of these major issues to the setting of a fee for a seminar.

Government Benefits Seminar Case Example

Advocates for Children, a 501(c)(3) private nonprofit agency, wants to conduct a one-day seminar for area social workers and volunteers on federal and state bene-

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fits available to children and families. The seminar will be a one-time activity and is designed both to provide a valuable service to the community and to generate a small profit to help support the agency. Advocates for Children is a midsize agency with a total annual operating budget of $750,000 consisting of $600,000 in direct (program) costs and $150,000 in indirect (overhead) costs. The agency’s indirect cost rate (using total direct costs as the base) is 25 percent.

The agency’s executive director plans to rent a conference room for the semi- nar. The conference room can accommodate a maximum of 60 trainees. The execu- tive director anticipates that the seminar will be fully subscribed (all 60 seminar slots will be filled). The executive director wants to set aside 10 slots for volunteers who will be charged only 50 percent of the seminar fee. The question that now con- fronts the executive director is, What should be the seminar fee?

The executive director prepares a budget identifying the costs involved in conducting the seminar (Table 11.1) assuming 60 trainees attend the seminar. The budgeted costs include (1) the rental of the conference room, (2) the rental of audio- visual equipment, (3) the cost of the four seminar leaders, (4) the cost of the semi- nar workbook that each trainee will receive, (5) the cost of the lunch that each trainee will receive, and (6) the cost of a coffee break that each trainee will receive. The total cost of the seminar as identified in the budget is $4,360.

Having completed the budget, the executive director decides to use Figure 11.1 as a checklist in helping to determine the fees for the seminar. Following Figure 11.1, the executive director immediately realizes that the budget does not contain all the direct and indirect costs of the seminar because no agency indirect costs (over- head) are included. In order to include agency indirect (overhead) costs in the cost of the seminar, the executive director multiplies the total budget costs (direct costs) of the seminar ($4,360) by 25 percent. The resulting figure, $1,090 is then added to the budget (Table 11.2) for a revised figure of $5,450. Since the facilities and equip- ment are being rented, their costs are already included and no need exists to con- sider depreciation and use allowance. Unallowable costs will not be a problem because no governments or foundations will be directly paying the seminar fee. In

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TABLE 11.1 Government Benefits Seminar

Proposed Budget

1. Conference room rental $ 250.00 2. Audiovisual equipment rental 100.00 3. 4 presenters @ $500 2,000.00 4. 60 workbooks @ $15 900.00 5. 60 lunches @ $15 900.00 6. 60 coffees @ $3.50 210.00

Total costs $4,360.00

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terms of profit, the executive director decides to factor in a margin of 5 percent. The 5 percent profit margin is applied to the revised budget figure of $5,450 (Table 11.2). The computed profit margin ($273) is then added into the budget, resulting in the figure of $5,723.

The executive director now computes fixed and variable costs and deter- mines a tentative break-even point. As Table 11.3 demonstrates, the variable costs of the seminar include (a) workbooks at $15 each, (b) lunch at $15 per person, and (c) the coffee break at $3.50 per person. All other costs of the seminar are fixed costs.

The executive director decides to set both the break-even point and the go/ no-go decision point at 45 trainees. Even though the executive director fully expects 60 trainees to attend the seminar, by setting the BEP and the go/no go deci- sion point at 45, a margin of error is built in for uncontrollable variables (e.g., bad weather on the day of the seminar). If a minimum of 45 full-pay trainees attend the seminar, Advocates for Children will at least break even on the seminar. If more than 45 full-pay trainees attend the seminar, the agency will make an additional profit (over and above the 5 percent) because, at 45 trainees, all the seminar’s fixed costs will be covered. The difference between the seminar fee and the variable cost will be pure profit. Using the BEP formula, but solving for price (or fee), the exec- utive director determines a tentative fee for the seminar of $116 (Table 11.4).

The executive director knows that other agencies in the community charge fees of $125 to $150 for comparable one-day seminars and workshops. Conse- quently, the tentative fee is below community market prices. The executive direc- tor now has to factor into the tentative fee, a price differential to account for the loss

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TABLE 11.2 Government Benefits Seminar

Proposed Budget

1. Conference room rental $ 250.00 2. Audiovisual equipment rental 100.00 3. 4 presenters @ $500 2,000.00 4. 60 workbooks @ $15 900.00 5. 60 lunches @ $15 900.00 6. 60 coffees @ $3.50 210.00

Total costs $4,360.00

7. Indirect costs @ 25% of $4,360.00 $1,090.00

Subtotal $5,450.00

8. Profit margin @ 5% of $5,450.00 $ 273.00

Total $5,723.00

Financial Management for Human Service Administrators, by Lawrence L. Martin. Copyright © 2001 by Allyn and Bacon, a Pearson Education Company.

ISBN : 0-536 -12114-1

of revenue associated with the variable or sliding fee schedule involved in offering ten volunteers a half-priced fee. As Table 11.5 demonstrates, if Advocates for Chil- dren offers ten volunteers a reduced fee ($58), the revenue loss will be $580. To off- set this revenue loss, the $580 is apportioned among the 50 full-pay trainees. The result is an increase of $12 in the full fee from $116 to $128. The fee of $128 is still on the low side of community market prices. Note that because of the new full fee ($128), the reduced fee ($58) is no longer exactly 50 percent less than the full fee.

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TABLE 11.3 Government Benefits Seminar

Identification of Fixed and Variable Costs

Fixed Costs

1. Conference room rental @ $200 $ 250.00 2. Audiovisual rental @ $100 100.00 3. 4 presenters @ $500 2,000.00 4. Indirect (overhead) costs @ 25% 1,090.00 5. Profit margin @ 5% of total costs 273.00

Total fixed costs $3,713.00

Variable Costs

1. Workbooks @ $ 15.00 2. Lunches @ $ 15.00 3. Coffee @ $ 3.50

Total variable costs $ 33.50

TABLE 11.4 Computation of the Seminar Fee

Using Forty-Five Trainees as the Break-Even Point

XP = A + BX

45P = 3,713 + 33.50(45)

45P = 3,713 + 1,508

45P = 5,221

(Divide both sides by 45.)

P = $116.00

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Summary

This chapter has looked at a number of major issues that should be considered when setting fees for human service programs and other agency activities. The major issues identified in the chapter can be used by human service administrators as a guide in thinking through the fee setting process and arriving at a fee or fees that best serve the interest of clients, participants, the program or the activity, and the agency.

In the next two chapters, the subject changes to issues of revenue generation beginning with the topic of government contracts and grants.

E X E R C I S E S

Exercise 11.1

The child and family government benefits seminar was such a success that Advo- cates for Children will conduct a second seminar in an adjoining community. The executive director decides that this second seminar will attempt to maximize rev- enues. Consequently, no reduced fee schedule will be offered. All trainees will pay the full seminar fee. The seminar will take place in a smaller conference room than

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TABLE 11.5 Computing the Effect of Variable Fees on Seminar Revenues

60 trainees @ $116 = $6,960.00 50 trainees @ $116 = $5,800.00 10 trainees @ $ 58 = 580.00

Revenue $6,380.00

Revenue loss on 10 half-priced fees = $6,960.00 6,380.00

$ 580.00 (revenue loss)

$ 580.00 Increase in full fee to offset revenue loss = $11.60

50

Adjusted full fee = $ 128.00 ($116 + $12)

Revenue computations: 60 trainees @ $116.00 = $6,960.00 50 trainees @ $128.00 = $6,400.00 10 trainees @ $ 58.00 = 580.00

$6,980.00

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the earlier one. The room can only accommodate a maximum of 45 trainees. Here is the proposed budget for the seminar:

Proposed Seminar Budget

1. Conference room rental $175.00 $ 175.00 2. Audiovisual equipment Rental 75.00 3. 4 presenters @ $500 2,000.00 4. 45 workbooks @ $15 675.00 5. 45 lunches @ $12 540.00 6. 45 coffees @ $3.50 158.00

Subtotal $3,623.00

7. Indirect costs @ 25% of $3,675.00 $ 906.00

Subtotal $4,529.00

8. Profit margin @ 5% of $4,594.00 $ 227.00

Total $4,756.00

You are the executive director. Following the checklist in Figure 11.1, perform all the computations necessary to set a fee. What will your fee be? What is your break-even point? What is your go/no-go decision point?

Exercise 11.2

As the executive director of Advocates for Children, you have had a change of heart. You decide not to attempt to maximize revenues in this second seminar. You decide to exclude a profit margin in the fee computation, but you will include indi- rect costs. Additionally, the local United Way in the community hosting the semi- nar has guaranteed 45 participants. If fewer than 45 participants register for the seminar, the United Way will make up the difference. In exchange for this guaran- tee, the United Way has asked you to set the seminar fee as low as possible. Fol- lowing the checklist in Figure 11.1, perform all the computations necessary to set a fee. What will your fee be?

Exercise 11.3

Advocates for Children is considering operating a residential summer camp (to be called Camp Delmar) for children between the ages of 12 and 16 who have physi- cal and mental disabilities. The camp will be a “camp within a camp” in that another camp (Camp Oceanside) will provide transportation to and from the facil- ity and will allow Camp Delmar to use two dormitory-type buildings (one for boys, the other for girls) for a one-week period. Camp Oceanside will charge Camp Delmar a fee $125 per camper per week. The $125 is all inclusive (lodging, food,

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transportation to and from the camp, etc.). Although the two dormitories can accommodate up to 20 children each, the plan is that Camp Delmar will have only 10 boys and 10 girls.

As executive director, you develop a proposed budget for Camp Delmar:

Proposed Budget for Camp Delmar

1. 3 Supervising social workers @ $750.00 per week $2,250.00 2. 5 camp counselors @ $300 per week 1,500.00 3. 20 Camp Oceanside fees @ $125 per camper per week 2,500.00

Total costs $6,250.00

As the executive director of Advocates for Children, you decide (with the approval of your board of directors) not to include a profit margin or indirect (overhead) costs in determining a fee for Camp Delmar. Furthermore, a wealthy member of the board of directors has agreed to donate $2,500 to Camp Delmar in order to reduce the fee charged to parents. What will your fee be? What is your break-even point?

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