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%).

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.

Case Study: Beck D Dreams Childminding

What do you wish parents understood about the cost of running a childcare business?

"I think the biggest misconception is that the money parents pay, or the funding a provider receives, is essentially our income. It really isn’t. We are running a business, so before anything reaches us, there are a huge number of costs to cover.

There are the obvious costs such as utilities, insurance, resources, equipment and maintenance, but also training, safeguarding requirements, first aid, professional development, accounting, registration and all the other costs involved in keeping a setting safe, compliant and providing a high-quality experience for children.

As co-childminders, many of our business expenses effectively double. We can have two sets of insurance, registration/Ofsted-related costs, training and other professional expenses, so there are significant overheads that parents don't necessarily see.

We also choose not to provide meals, specifically to help keep our fees as affordable as possible for families. Parents provide their children's food, which helps us control costs and means we don't have to pass those additional expenses on through our fees.

Another important point is that childminders have the same ratios regardless of the age of the children we care for. The funding for 3-year-olds is particularly challenging because, in our experience, it is massively underfunded compared with the actual cost of providing the place. Unlike a nursery, our ratio doesn't become more favourable simply because a child is three. We still have the same number of places available and the same staffing and business costs to cover."

What are your biggest costs day to day?

"Utilities and household running costs are significant, particularly as we operate our childcare business from our home.

Then there are resources and equipment. We constantly invest in books, creative materials, outdoor equipment, furniture and activities because providing a stimulating environment is an important part of what we do.

There are also the less visible costs insurance, training, administration, accounting, registration and maintaining the setting.

We don't provide meals because keeping fees down for parents is important to us. However, that doesn't mean food isn't a consideration for families, and we are very conscious that the overall cost of childcare has to remain manageable."

How hard is it to keep prices affordable for parents?

"It can be really difficult. We completely understand that families are under financial pressure too, and nobody wants childcare to become unaffordable.

Parents also increasingly need flexibility. Some families don't need or can't afford a full day, so we offer hourly rates to allow parents to book the hours they actually need rather than paying for childcare they don't require.

However, this can have a massive financial impact on a small setting like Dreams. An unused hour isn't simply an hour we can sell later that place may have been reserved for a child, meaning we have lost the opportunity to fill it with another booking. When you're working with a very limited number of places, those unused hours can make a significant difference to the sustainability of the business.

There is a constant balance between giving families the flexibility they genuinely need and making sure the childcare business can survive."

How much does occupancy matter? do you struggle to break even if you don't have enough children?

"Occupancy is absolutely crucial. As a childminder, there is a limit to the number of children we can care for, so every place matters.

Our costs don't suddenly disappear because we have a vacant space. You still have the household costs, heating, electricity, insurance, resources, training and all the other running costs. If you have several unfilled places, it can make a significant difference to whether the business is breaking even.

This is also why unused hours can be so difficult. We want to offer parents flexibility, but if a booked place isn't fully utilised, we still have that capacity sitting there which we can't necessarily sell to someone else."

Do you reinvest money back into your setting, or is there rarely enough left over?

"We reinvest a huge amount back into the setting. For us, that is really important because we want children to have access to a high-quality, stimulating environment with plenty of opportunities and experiences.

A lot of what might look like "extra spending" is actually part of maintaining and improving the provision. New books, resources, equipment, training and improvements to the environment all cost money.

We also believe that rested childminders and rested children are vital. We do charge for our holidays, but we are completely upfront with parents about this from the beginning. We believe that taking time away from the setting is essential to being able to return refreshed and continue providing the quality of care families expect. We are very clear about our holiday arrangements so parents know exactly what they are committing to when they choose us.

The reality is that there isn't always a huge amount left over once everything has been paid for. Childminding can look like a very attractive business from the outside because you are working from home, but the reality is that you have to be very careful with your finances and constantly balance the needs of the children, the needs of families and the need to make the business sustainable."