Thus far, we have been espousing an approach which is broadly known as “Activity-costing”. In essence this is when all our transactions are attached to a relevant Account and Activity.
The reason we code at the point of transaction is such an approach gives us the most detailed analysis possible and ensures every dollar of income or expenditure in your accounting system that has an Account associated with it, also has an Activity. Posting both tags at the transaction-level also allows a single transaction to be split across more than one Activity and/or Account at the point of processing, an important issue for efficient and accurate bookkeeping. Even the most basic accounting software allows for this additional Activity tag, although some handle it better than others.
In case you were wondering, extra transaction tags are nothing new and are used in varying ways in financial management (we’re suggesting two tags but many systems will handle an unlimited number). In larger software systems the extra tags often form part of a free-form tagging approach, where an Account can be combined with any number of extra tags, that might represent ‘Cost-Centres’, ‘Departments’, ‘Categories’, ‘Locations’, ‘Programs’ etc.
Should you decide to apply Activity-costing to your financial management you are doing nothing weird or loopy, just something that thousands of other NFP’s have also done. It’s just that normal people generally don’t talk about it at dinner parties.
Using Activity and Account tags – why we need both.
We’ll be chatting in more detail about Account structures shortly, but it’s important at this stage that we’re very clear about how an Account and Activity work together. As mentioned above, an Account is a tag that defines the good or service type (well it’s actually more complicated than that but for our purposes that will suffice). It represents a generic description of what is being purchased or sold. ‘Travel’ is an example of an expense Account. ‘Grants’ is an example of an income Account.
An Activity, on the other hand is an additional secondary tag that defines the Program or Service that the transaction is being undertaken to support. ‘Youth Support Initiative’ might be an example of an Activity, so too “Family Outreach” etc. The Activity represents the real-world description of what program or service is being provided.
It’s important to understand that a transaction is tagged by a combination of any Account and any Activity. They are independent of each other but combine as required. A couple of examples: If the manager of the ‘Youth Support Initiative’ purchased an airline ticket - when the invoice for the ticket was processed in the accounting system the Account tag would be ‘Travel’ and the Activity tag “Youth Support Initiative”. In the next payroll, the manager’s salary would be posted to the “Salaries and Wages” Account but the Activity tag would remain “Youth Support Initiative”. The Account reflects the generic expense ‘type’; the Activity reflects the real-world program or service.
Many an organisation has been tempted to simply combine both the Account and Activity into a single Account tag, just by adding an extra description e.g. ‘Travel – Youth Support”. This in theory is fine until you end up 35 travel accounts each with their own extra description. The manager responsible for ‘Youth Support Initiative’ has no idea how to extract their travel expenditure from all the other accounts in the travel area, and certainly has no idea how their other relevant accounts are performing. Even in small organisations you end up with a list of Accounts that get muddled, quickly out-of-date and hard to report on.
The real beauty of using an Activity-costing structure is the efficiency it brings in reporting. It is very easy to extract a financial report for a particular Activity, that will show only income and expenditure Accounts with transactions relevant to that Activity. We can build Models, convert them into Budgets and report our Actuals for individual Activities, an Activity Group or the whole organisation clearly and efficiently.
In a nutshell, using a well-structured generic Accounts list combined with an appropriate number of Activities is the only practical way to accommodate all stakeholders in an uncomplicated and efficient financial management system.
Identifying and Applying an Activity-costing structure
Whilst all NFPs’ have a good handle on what they do in a real-world sense; that doesn’t mean it’s easy to immediately reflect that in a financial sense. Keep in mind we are trying to identify a series of programs and services that between them encompass everything your organisation does. We can then categorise them into Activity Groups reflecting their similar purpose. Here’s a starting point:
- Look at your constitution and/or Strategic Plan if you have one. As a general rule, your Activity list starts with your organisation’s outputs – your programs and services. These documents often portray them in a succinct manner.
- Look at your communication material and annual reports. When we prepare information for people outside the organisation we often draw together our work into bite-size chunks, perfect for identifying Activities and Activity Groups.
- Look at your operational and/or staff structure – often these reflect real-world programs and services, but they can also highlight campaigns or other work that are critical to the organisation’s output, but may not be communicated as strongly to external stakeholders e.g. fundraising, membership, sponsorship etc.
- Identify Programs and Services that are individually funded as they will generally require separate Activity codes. This assists reporting and financial analysis throughout the program and acquittals if required at its conclusion.
- Don’t neglect your Core operations / General Admin / Corporate Services – whatever term you use. It’s absolutely critical that this area is considered an Activity in its own right - try running your organisation without it. But apart from that, you will need a solid understanding of your so-called ‘core overhead’ when building a Costing Model - more on that shortly.
- Activities should encompass not only those things you are doing now but should include programs or services you have aspirations to undertake. Whilst initially such Activities may only bob-up in Models, such an approach is an excellent way to prioritise your aspirations and communicate with all stakeholders (Boards, funders, members, staff) what you would do next if you had additional resources.
- Fine-tuning your Activity list over time is normal. Often it takes a couple of years to apply a consistent approach to identifying and grouping Activities, but you’ve got to start somewhere. This is not an error, it’s a sign that you’ve embraced Activity costing and you’re simply finding the right balance. For what it’s worth, generally we find organisations reduce the number of Activities over time, rather than increase them. Less is more in Activity-costing; as such it is worth continually challenging the Activities you’ve chosen and assessing whether the financial information is being used for each.