United States: Fixing The Overhead Myth

Last Updated: September 27 2015
Article by Grant Lam

Although the nonprofit sector is taking steps to end the "overhead myth," which equates low overhead with success and ignores other critical factors, many organizations are still measured by their financial ratios and spending instead of their outcomes. This misguided approach can threaten a nonprofit's mission and its long-term survival, so organizations need to educate funders about the true cost of their work and shift the focus to their results.

Low costs don't mean high performance

A nonprofit has three main categories of expenses. Program costs are those directly related to the activities for which a nonprofit exists. Fundraising costs are tied to the activities an organization undertakes to obtain contributions. Management and administration costs are not identifiable with a specific program or fundraising activity, but are essential to the conduct of those activities and to the nonprofit's existence. This includes things like management salaries, utilities, equipment and other infrastructure costs. Together, fundraising costs and management and administration costs make up overhead costs.

Although overhead allocation is an important metric to track―it can be used to spot fraud or poor financial management, for example―it is misleading when viewed by itself, because it shows nothing about a nonprofit's impact, such as how many people a soup kitchen feeds or a homeless shelter houses. Yet many funders are still mistakenly tied to the notion that low overhead means an organization is highly effective, and high overhead means it is a wasteful poor performer.

Nonprofits have been judged by their overhead for decades, but the metric has become more influential in recent years with the rise of big data analytics and charity rating sites that focus on financial ratios, as well as the public's demand for quick statistics to gauge a nonprofit's performance. Donors have adopted the false mantra of "low overhead equals success" and have relied on rating sites as an easy-to-use indicator of an organization's effectiveness. Nonprofits also have made the problem worse, by highlighting their low overhead and ratings in their fundraising materials.

The dangers of insufficient overhead

Buying into the overhead myth can jeopardize an organization in several ways. A nonprofit that focuses solely on keeping overhead costs low is likely to defer spending on employee training, technology and other critical investments, and this can threaten its day-to-day mission as well as its long-term viability. Outdated software may limit an organization's ability to execute a successful online fundraising campaign, for example, or poorly trained staff may not have the skills to do their jobs effectively.

Nonprofits may also be motivated to misclassify overhead expenses as program costs. This puts them at risk of not knowing their true overhead costs―a danger for any entity, because management relies on accurate financial information to make informed and strategic decisions. Underreported overhead costs may lead management, funders and stakeholders to conclude that the organization is running effectively and that overhead spending is sufficient, when in reality, the exact opposite is true.

It's not unusual to see nonprofits report implausibly low fundraising expenses. The 2004 Nonprofit Overhead Cost Study, a project conducted by the Urban Institute and the Center on Philanthropy at Indiana University, found that 37% of nonprofits with private contributions of $50,000 or more reported no fundraising or special event costs in 2000. In addition, nearly 13% of the operating public charities studied reported spending nothing for management and general expenses.

These effects are part of the "nonprofit starvation cycle," a term taken from the title of an article in the Fall 2009 Stanford Social Innovation Review. In this vicious circle, funders have unrealistic expectations of how much it costs to run a nonprofit, which results in nonprofits misrepresenting overhead and underspending on vital costs, which then further perpetuates the funders' skewed and unrealistic expectations. The end result: Nonprofits are constantly asked to do more with less.

How much overhead is enough?

So what is the right amount of overhead? There is no single answer, or even a general range, because it depends on so many variables. Is an organization young and still building out its infrastructure, or is it already established? Is it launching a new program or expanding to a new location? Any of these factors can significantly impact a budget, so each nonprofit must analyze its needs and make its own determination.

Although not a perfect analogy, comparing the cost structure of a nonprofit organization to that of a for-profit company can offer some telling insight into the reasonableness of average nonprofit overhead costs. A for-profit organization typically incurs overhead expenses at an average of 25% to 30% of total expenses. Successful, highly innovative companies such as Google and Apple invest heavily in human capital and infrastructure, and report significantly higher overhead. Imagine the results if nonprofit overhead expectations were applied to the for-profit sector, and for-profit companies were asked to keep overhead costs below 20%.

Solving the problem

An inadequate overhead budget can slowly destroy a nonprofit's ability to meet its mission, yet donors want to see low expense ratios. It's a longstanding dilemma that will take time to solve, but it can be fixed.

The first step is figuring out what it really costs to run your nonprofit effectively. Determining this takes cooperation from your entire organization, so you need to educate every staff member about why the information is so critical. For example, everyone needs to understand the importance of accurately tracking their time and reporting it on their timesheets. The accounting department needs to be well trained on how to allocate functional expenses, and the tone from the top should stress the importance of accurately reporting costs.

After you've determined your true costs, you need to report them and educate your stakeholders about them. You have to show what your organization requires to operate effectively and tell funders how their dollars are being used. What does it cost to provide an after-school program for each at-risk teen, or how many breakfasts does their contribution buy for hungry kids?

Maintaining transparency with donors and stakeholders is the key first step toward ending the overhead myth. As part of maintaining transparency and building that trust, nonprofits also need to identify and report the true costs of their organization. As more organizations determine their costs and better communicate the story behind them, nonprofits can shift stakeholders' focus to the most important measure of their success: the outcomes they achieve.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.