How The Wrong Indirect Cost Rate Can Damage Your Business

The following is from Ed Jameson’s talk about indirect cost rates and SBIR accounting at the National SBIR Conference. This overview contains the key points you need to know.

Indirect cost rates fund your business.

We have clients all over the country. They’re in Silicon Valley, Boston, the Carolinas, Texas… and they’re asking for the indirect rates that they need to fund their business, and the government funds them because the government wants to pay your reasonable allowable expenses.

It’s your responsibility to ask for the right indirect cost rate.

Here’s the thing: if you don’t ask for the money, the government is not going to ask for it for you. If you don’t ask for the right indirect rate, the NIH or DOE or NSF or DOD isn’t going to put you out of business, you’re going to put yourself out of business. Too often, people prepare proposals and don’t ask for an adequate indirect cost rate because they want to be competitive. However, if you believe in your idea, your innovation, then you must ask for the money you need to succeed!

Indirect rates that are too low create a cash flow problem proportional to the degree of the miss.

Let’s say you’re a bootstrapped company. You have a great idea, but you’re running lean. When you fill out your proposal and request an indirect cost rate you ask for a 50% overhead rate, but your actual overhead rate runs at 80%. How big of a cash flow problem do you have? 30% – that’s how big the pain is going to be.

What does that “pain” look like? You know you’re in trouble when, to keep your business running, you:

• Take money out of your personal bank account
• Stop taking a salary
• Increase credit card debt
• Take out a second mortgage
• Borrow from relatives
• Prematurely dilute your company
• Seek Series A Financing

The bottom line is this: If you propose the wrong indirect rate, you’re going to dig your business into a financial hole, you’re going to go into debt, you’re going to dilute yourself, and you’re going to cut corners.  Just as important, you will be unprepared and unable to handle funding glitches. If you don’t plan for funding glitches – the next thing you know you’re firing everybody because you don’t have an adequate indirect rate to cover downtime and other natural business events.

The wrong indirect cost rate can lead to inadvertent fraud.

The following scenario happens more frequently than it should… with disastrous results.

You’re a grantee with an F&A rate that’s too low, you’re always strapped for cash. You go into the NIH Payment Management System or the DOE ASAP system, and you start drawing down money. You may not be 100% sure if you’re entitled to these funds, but they’re available and your company needs them.

Over a few months, let’s say you draw down $375,000. Then, at the end of the quarter, you have to fill out the SF-425 which is also known as the Federal Financial Report or FFR, which is where you are supposed to report actual project costs, which should agree to what you drew down. So you could potentially be getting yourself in a lot of trouble because the form requires you to attest that all the money you drew down was appropriate in accordance with FAR part 31.  Note, just above the signature line, read line 13 which says: By signing this report I certify that it is true, complete and accurate to the best of my knowledge. I am aware that any false, fictitious or fraudulent information may subject me to criminal, civil or administrative penalties.

If you’re not entitled to the funds, you have to pay them back, sometimes with stiff penalties that range from fines to award termination.

The bottom line for this scenario: Just because you can push the button, and the money shows up in your bank account the next day does not mean that’s what you should do.

Get the help you need with your indirect cost rate.

At Jameson & Company, we are experts at helping our clients propose the right indirect cost rate, and we do it for FREE as a way to introduce ourselves!

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This is the first of a five-part series about indirect rates. 

1. How The Wrong Indirect Rate Can Damage Your Business
2. How to Project an Indirect Cost Rate
3. How to Project an Indirect Cost Rate for a Phase II Proposal
4. Real Life Examples of a Reasonable Indirect Cost Rate
5. Understanding The Indirect Cost Rate Cycle