England’s nurseries are surviving on a financial tightrope

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%).