The fragile financial model keeping 21,000 nurseries afloat
New research by money.co.uk business loans experts has uncovered a hidden imbalance in England’s childcare funding system: the government overpays nurseries for funded places for children 2 and under, while significantly underpaying for three and four-year-olds. Many nurseries are only staying afloat by using the surplus from one to cover the shortfall from the other — a model that becomes increasingly fragile as more older children take up their funded entitlement.
Analysis of 2025 Department for Education data shows that government funding for children under two exceeds average nursery fees in every region of England, by as much as £3.57 per hour in the South East. For three and four-year-olds, the picture is reversed: funding falls short of average fees in every region, by up to £2.07 per hour in London — a gap worth £2,360 per funded child each year.
The hidden cross-subsidy
The result is a cross-subsidy baked into nursery finances. Providers rely on the surplus generated by funded under-two places to offset the losses they make on funded three and four-year-old places. As long as the mix of children in a setting stays relatively stable, the model just about works.
But that balance is fragile. As the government continues to expand its funded childcare offer — encouraging more families to take up their entitlement — nurseries risk seeing their proportion of three and four-year-old funded places grow. Each additional funded older child adds to the shortfall without a corresponding increase in the surplus from younger children. A shift in occupancy mix of even a few places could quickly push a provider from a narrow profit into a loss.
Funding gap for three and four-year-olds by region
Region | Avg hourly fee | Hourly gap | Annual gap per child |
London | £8.60 | £2.07 | £2,360 |
South East | £7.03 | £1.21 | £1,379 |
East of England | £6.74 | £1.17 | £1,334 |
West Midlands | £6.42 | £1.02 | £1,163 |
South West | £6.37 | £0.92 | £1,049 |
East Midlands | £6.14 | £0.80 | £912 |
North East | £6.06 | £0.79 | £901 |
North West | £6.02 | £0.60 | £684 |
Yorkshire and The Humber | £5.82 | £0.40 | £456 |
Thin margins leave little room for error
The financial precariousness of nurseries runs deeper than the funding gap alone. The average private nursery in England makes just £933.66 profit per child each year — around £78 per month — after operating costs. Providers must fill at least 31 places (60% of registered capacity) before covering their costs at all.
Staffing accounts for around three quarters of total expenditure, reflecting strict government-mandated staff-to-child ratios that cannot be reduced regardless of financial pressure. Rent or mortgage payments account for a further 9%, followed by food (4%), materials (3%), business rates (2%) and energy bills (2%).
Case study
Morgan Ridley, owner of Morgan’s Childcare based in Sawbridgeworth, Hertfordshire, said: “There are so many costs involved in being a childminder that people don’t always see. Everyday essentials like nappies, wipes and food all add up, and with rising prices there’s very little room for unexpected expenses.
“I also wish more parents understood how childcare funding works. The funding rates vary depending on a child’s age, and for three-year-olds the amount I receive is actually lower than my usual fee, meaning I lose money on funded places.
“Occupancy is one of the biggest factors in keeping my business sustainable. It’s not about maximising profits — it’s about making sure I can cover my mortgage, bills and other running costs so I can continue supporting local families for years to come.
“Any surplus I do make is reinvested back into my setting — whether that’s introducing new experiences, buying new toys and learning resources, or improving the environment for the children.”
Expert comment
Matt Browning, money.co.uk business loans expert, said: “What this data reveals is that England’s childcare funding system contains a structural imbalance that many people — including parents — are completely unaware of. Nurseries are not simply charging what they need; they are navigating a funding model that pays generously for some age groups and falls significantly short for others.
“The risk is that as the government’s funded hours expansion takes effect and more three and four-year-olds take up their entitlement, the cross-subsidy that keeps many settings viable begins to break down. A nursery that was just about covering its costs could find itself in difficulty simply because its occupancy mix has shifted — through no fault of its own.
“Providers that understand this risk can take steps to protect themselves — whether by reviewing their financial planning, maintaining a healthy mix of funded and private-paying places, or using flexible finance to build resilience against periods of lower income or unexpected costs.”