Nonprofits and the Overhead Conversation

In Florida Nonprofit Alliance’s 2022 research, Giving in Florida, Florida donors tell us one of the top reasons they stop giving to nonprofit organizations is because the organizations are mismanaging financial resources and spending too much on administration and fundraising expenses. Although there are examples of financial mismanagement among the more than 27,000 nonprofits in the state of Florida, they are rare. The vast majority of nonprofit organizations operate in ethical, transparent ways that maximize resources for the communities they serve.

So why the disconnect between what donors perceive, and what is actually happening in the sector?  We believe it stems from how nonprofit expenses are defined – overhead, or indirect, costs that appear at first glance to be taking away from the program work.  However, overhead is not bad – in fact, it is vital to the health and success of nonprofit organizations.

 

What is Overhead?

Overhead ratio is the amount of a nonprofit’s finances that is dedicated to costs that don’t seem to be associated directly with program delivery (i.e. rent, some employee salaries, technology, audit costs, fundraising costs, utility bills) compared to the amount dedicated to program or direct service spending.  Nonprofit organizations share this information on their IRS Form 990 each year, and it is also often included in external audits that some organizations participate in. 

For many years, some donors, funders, media, and other decision makers have used this ratio to measure the effectiveness or worth of a nonprofit organization. The organizations that spend the least amount on overhead are perceived as being “better” or more worthy of donations, while those with higher overhead costs are perceived as being a poor investment of charitable dollars. In fact, NPOInfo’s charitable giving statistics state that a whopping 61% of donors claim to choose which nonprofits to support based on how “well” the organization utilizes its funding.

 

Why is Overhead a Poor Evaluation Tool for Nonprofits?

Spending money on overhead costs is neither a reliable method of evaluation, nor is it a bad thing for nonprofits to invest in.  Overhead isn’t an accounting term, so each nonprofit organization may be defining overhead costs and how they are assigned differently. Comparing overhead rates between organizations will not give you a true picture of an organization’s business operations.  In addition, many community nonprofits mistakenly overstate their overhead costs on their Form 990 because of the vagueness of the “management and general expenses” category they are required to complete.

Also, all businesses, including nonprofit ones, need to spend money on overhead costs to survive.  Would you expect a manufacturing company to only spend money on machines that make the product?  No, you know there are other expenses that the company incurs – salaries for C-Suite employees, professional development, research, etc.  The same applies to nonprofit businesses.  No organization will be able to provide quality services on a sustainable basis without spending money on the people who run the organization and the resources they need to get the job done.

Using overhead as a measure of success is likely to keep nonprofits from being innovative and solving the problems they are designed to solve.  It also limits who can afford to work in the sector by unintentionally capping salaries, which stops talented people who may otherwise be willing to do nonprofit work from taking nonprofit jobs.  And it creates a “starvation cycle” for organizations, where nonprofits keep their overhead costs unreasonably low in order to encourage future donations - even if cutting those costs actually hinders their ability to carry out core mission work.

 

What is an Acceptable Amount to Spend on Overhead?

There is no right answer to this question – what is most important is identifying the amount of overhead that is appropriate for your organization and the mission you are trying to achieve.  It vitally important to not spend too little on overhead – underinvesting in nonprofit infrastructure puts organizations at serious risk.

A quick Google search reveals that the common guidance is to keep nonprofit overhead in the 20-35% range. In 2012, the average American believed that a nonprofit should not spend more than 23% on overhead. The Better Business Bureau Wise Giving Alliance recommends that no more than 35% of related contributions be spent on fundraising. But none of this information should not be taken at face value – every organization needs to figure out the appropriate amount of overhead for their particular mission, community, and organization. 

For context, Harvard University has a 68% overhead rate for on-campus research, while Iowa State University has a 48% rate.  In the for-profit world, Rand Corporation reports that airplane manufacturers have an average overhead rate of 35% while Trinity Marketing reports 55% as an average rate in advertising agencies.

 

Rather than setting an arbitrary percentage goal for overhead expenses, we recommend asking instead:

  • What is the impact that my nonprofit is having on its mission work?
  • What resources and infrastructure (including staff) do we need to be successful in the programs we provide?
  • Can we accurately and compellingly describe our overhead needs to those outside our organization?

Providing those answers to funders and donors is often the first step in alleviating their concerns about overhead spending.

 

How Should Nonprofits Discuss Overhead?

If overhead is important to nonprofit success, and using a straight percentage to calculate overhead won’t work, how should we address this issue that remains so important to donors? Here are some ideas.

  • Describe overhead as “funding core mission work.” Overhead expenses aren’t optional, and an organization that is operating with too little overhead will likely not be sustainable in the long run.
  • Understand what your true costs and infrastructure needs are. Unless you can clearly articulate those two things, you will not be able to recruit others to help you.
  • Be vulnerable about the true cost to run your organization. Use your Board, trusted funders, and staff to tell the full story of your organization’s needs. Use the pandemic as a leveling ground – all sectors of our economy had to pivot during the pandemic, so they should understand the current struggle that nonprofits have in funding things like salaries, technology, and program adaptations.
  • Don’t allow funders and donors to pit you against another nonprofit. Educate your donors about your overhead needs. If they try to make the conversation about how much your overhead is, change the conversation and don’t fall back into the trap of underestimating or belittling the resources your organization needs to be successful. It’s all about the impact that nonprofits have in their communities and the change that we bring with our investments.
     

 

For more information, we recommend the following resources: