Mistake #1: Taking the NIH Safe Rate and Endangering Your Business
When you receive a Phase II SBIR, STTR, RO1, APRA-E, BARDA or BAA grant or contract, you need to comply with the Federal Acquisition Regulation (FAR) Part 31, and specifically FAR 52.216-7. After more than 30 years of specializing in government grant and contract accounting, our CPAs know the mistakes government contractors and grantees make, and how to prevent them. This 10-part blog series, “Top 10 Mistakes Government Awardees Make,” is designed to help you avoid trouble and protect your innovation and business.
WHAT YOUR FRINGE AND F&A RATES WILL MEAN TO CASH FLOW
After winning an NIH Phase II SBIR award, most people feel a tremendous sense of relief. They were awarded $1.5M —no money worries for months to come.
But there’s a problem, and we see it all the time: NIH SBIR Phase II award winners write a cost proposal WITHOUT understanding there’s a difference between what something will cost and how it will be charged in their accounting system. They don’t recognize the profound cash flow impact “the way” they asked for the money is about to have on their business.
HOW THE SAFE RATE CAN PUT NIH SBIR PHASE II AWARDEES AT RISK
We understand that winning an NIH SBIR Phase II is incredibly competitive, but asking for a 40% F&A rate, or a 20% F&A rate, or a 5% F&A rate without understanding what you actually need can be suicidal for your business.
When you propose an NIH Phase II SBIR (or STTR) and take the safe rate – a 40% F&A rate or less – you do NOT negotiate your fringe and F&A rate with the Division of Financial Advisory Services (DFAS).
Therefore, you do NOT have a negotiated indirect cost rate agreement (NICRA).
If you don’t have a NICRA, whatever indirect cost rate you proposed is CAPPED.
THE IMPACT OF PROPOSING FRINGE AND F&A RATES THAT ARE TOO LOW
At a minimum, proposing fringe and F&A rates that are too low creates immediate cash flow problems. Those problems are proportional to the degree of the “miss.”
If you bill the government for your direct costs plus a 30% rate for projected F&A costs and your actual F&A rate runs at 75%, you are operating at a 45% deficit and will have to make up the difference.
What are the root causes of the 45% miss?
As we said earlier, many awardees understand what something costs, but not how to CHARGE the cost in their accounting system. That’s because:
- their accounting system is set up improperly
- they don’t understand the difference between a direct cost, an indirect cost and an unallowable cost
This is so common that we run monthly webinars to educate people about it.
An insanely overly simplistic example:
Let’s say you hire a $100,000 employee for your NIH SBIR Phase II project.
When creating your proposal, you assumed a $100,000 charge to direct labor, $30,000 for rent, and zero for indirect labor:
Indirect costs $30,000
Direct Labor $100,000
F&A rate proposed 30%
The reality is this person charges 25% of their time to indirect labor as they take vacation, holiday and sick days off; and charge their timesheet for writing proposals, managing employees, and spending time talking to lawyers and accountants. This 25% or $25,000 should be properly charged to INDIRECT labor, not direct labor on the NIH SBIR Phase II. (Please don’t make us remind you how seriously the government takes timesheet manipulation).
Your actual F&A rate looks as follows:
Indirect costs $55,000 ($30,000 for rent and $25,000 for indirect labor)
Direct Labor $75,000 ($100,000 for labor – $25,000 charged to indirect)
Actual F&A rate 73.33%
Oops, and you forgot to add payroll taxes, which adds another ~$8,000 to indirect costs:
Indirect costs $63,000 ($55,000 from above, plus $8,000)
Direct costs $75,000
Actual F&A rate 84%
Hopefully, you also noticed the shifting costs from the denominator to the numerator can have a > 1:1 impact on your fringe and F&A rates.
3 WAYS TO DEAL WITH FRINGE AND F&A RATES THAT ARE TOO LOW
There is no easy way to solve the cash flow problem you’ll create if you’ve taken indirect cost rates that are too low.
How you deal with the difference between your proposed indirect rates and your actual indirect rates will determine the size of the problem you create for yourself:
- Method 1 – Do the accounting correctly and then borrow from credit cards, your personal savings, the local bank, family and friends; or dilute yourself by selling equity prematurely.
- Method 2 – Do the accounting incorrectly. Then, when you improperly assume you’ve earned all the money you’ve drawn from the Payment Management System and fill out form SF-425 improperly, you’ll be on the inadvertent fraud route.
- Method 3 – Again, do the accounting incorrectly. As a result, you won’t understand what’s driving the cash flow problems in your current award (the ridiculously low indirect cost rate), and you’ll borrow funds from your next job to cover the shortfall. (aka “borrow from Peter to pay Paul”). This is obviously not in compliance with the NIH Grants Policy Statement or FAR Part 31 and will result in major financial findings in a Uniform Guidance Audit as well as the inadvertent fraud problem.
GET THE HELP YOUR BUSINESS NEEDS
The government wants your business to succeed. However, they are not going to make sure you fill out the cost portion of your proposal correctly. We will.
If you’re concerned about your indirect cost rate or need some assistance projecting one, contact Ryan at firstname.lastname@example.org or 781.862.5170 ext. 2106.
Check out one of our webinars on indirect rates. They are free, an hour long and we have many of them in our archives.
Download our free indirect rate planning template. This is what we use for our clients and it will help you arrive at a reasonable, projected indirect rate.
We have a series of short, informative videos on indirect rates from Ed’s presentation to the National SBIR/STTR convention. Start here.