I have been taught that calculating the true funding cost is more accurate using method 1 than method 2 (shown below):
[Vars: Fa=percentage funding cost, P=amount of money raised, T=true funding cost]
1. T = P/(1-Fa)
2. T = P + P*Fa
Why is this so? Why do they not equal each other?
Your help is much appreciated.
In general, the COST required to raise money is deducted from the TOTAL amount of money raised.
If you are to raise some money & you spend a few dollars for postage, telephone, gasoline, office space, and so forth, you expect to be repaid your out of pocket expenditures. Say you raise $1000 and your total costs were $50, or 5% of the amount raised.
However, the fund would not report income of $1000. The fund would deduct your costs (5%) from the $1000 and then record $950 as the amount raised.
Note: If you had raised $1052.63 and then deduct the 5% (5% of 1052.63 is $52.63) the fund would report and income of $1000.
It cost an additional $2.63 to raise the additional $50.
In this example:
T = P/(1-Fa)
The cost to raise the money is deducted from the money raised.
If the fund has a benefactor (or an isolated method of paying for costs (your out of pocket money), then your expense would be paid by a different source -- or more likely you'd say just forget about the minor expenses; you absorb the cost or don't require coverage for your small expenditures. The fund would report that $1000 had been raised (at zero cost to the fund).
T = P(1+Fa)
The cost to raise the money is paid by someone else.
Hope that is meaningful.