The Professional Association for Childcare and Early Years (Pacey) asked 2,219 early years practitioners - 85 per cent of who were childminders - about how the policy was working in practice.
It found that 41 per cent of childminders and 46 per cent of practitioners in group settings saw their profits fall as a result of taking part in the funded places scheme.
Introduced in September 2017, the policy entitles most working parents of three- and four-year-olds in England to 30 hours of funded childcare. Childcare settings that offer these free places are then paid an hourly rate by their local authority.
Around three quarters of practitioners who took part in Pacey's Building Blocks survey said the hourly rate their local authority pays is not sufficient. Some 44 per cent of childminders told Pacey they do not believe they can keep offering funded places long term and a third already plan to limit the number of free entitlement places they offer families in the future.
"We already know many childminders, nurseries and pre-schools are struggling to make ends meet whilst offering 30 hours for the families they support, but our latest Building Blocks research is a stark reminder of how many are actually losing money," said Liz Bayram, chief executive of Pacey.
"As business costs continue to rise and profits fall, the sustainability of many of these settings has to be called into question. The government has said it will look at funding levels for 2020 onwards as part of the Comprehensive Spending Review, but that is two years off and action is badly needed now."
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Pacey's survey also found unhappiness among practitioners about how councils administer the 30 hours policy.
Only a fifth said their local authority paid them monthly and a third said their council makes them deal with complicated funding portals. A quarter of childminders said they had encountered problems in getting paid by their council for the free places they had provided and one in five practitioners said councils had made them send in policies or undergo specific training prior despite government guidance to the contrary.
The report said such actions are threatening the viability of small childcare businesses.
"This can cause serious cash flow problems, which can be very damaging for small businesses operating on very low or no profit margins," said the report. "The statutory guidance advises local authorities to dispense payments promptly, and to pay childminders monthly by September 2018."
Of the practitioners who did not offer funded places, 43 per cent said this is because the hourly rate is too low and another 31 per cent blamed the bureaucracy involved in being part of the scheme.
Bayram called on the government to take action on the problems its survey found. "The government must urgently increase funding levels and establish a formal annual review, so that funding keeps pace with inflation; pay providers on a monthly basis as soon as possible; and ensure local authorities streamline their paperwork and remove unnecessary demands for additional documents and training," she said.
Worries about funding levels have dogged the 30 hours free childcare offer since its inception. A number of organisations have raised concerns about the policy's impact on the sustainability of the childcare sector including the Federation of Small Businesses, the National Day Nurseries' Association and the Pre-school Learning Alliance.