In the devastating wake of Hurricane Harvey, a number of articles have made the rounds, listing which nonprofit organizations the public should donate to (or not donate to). Inevitably, these organizations are ranked based on what percentage of donor dollars go towards programs as opposed to management/general expenses, commonly known as "overhead." While overhead can certainly be a factor in judging an organization’s effectiveness and overall financial health, it is important for the public to remember that these expenses are only one part of the big picture.
Overhead costs are necessary for any organization - nonprofit and for-profit alike. Overhead can include things like computers and software that keep track of programs and analyze outcomes, training and salaries for staff, rent, pencils, stamps, paper, phone service, internet service, accounting and legal services. To quote this SSIR article (an old one, but a good one), "You can't run a high-performing organization from your car."
Some organizations have inherently higher overhead costs than others. A worldwide organization providing emergency medical services might have a massive infrastructure with hundreds of offices, medical databases, contractors, training and certification needs - all of which cost money to maintain and upgrade. If this organization doesn’t invest in infrastructure, their databases might crash in emergencies, their staff and volunteers would lack appropriate training and direction, and they would not be well-positioned to respond quickly to disasters around the world.
On the other hand, a small organization offering web-based community services might only have one or two people on staff, a home office, and limited overhead costs. But that's because they have fewer operational demands, not necessarily because they're more effective. That doesn't mean this small organization is not effective either - it just means that overhead costs alone are a poor way to judge an organization's efficacy.
Unfortunately, donors don’t always understand the decisions or operational necessities that make up overhead costs. They might simply see a percentage on your Form 990, and assume that tells the whole story. Communication is key in helping your donors understand not only what your overhead costs are, but why they are crucial to your mission.
There is also a pervasive and sometimes overwhelming confusion in the nonprofit sector regarding expense classification and reporting. For example, two different organizations pay their Outreach Coordinator an annual salary of $50,000:
Organization A is a small operation with a volunteer bookkeeper. In an attempt to keep their overhead costs down, they do not seek out the services of a trained CPA. This organization assumes (logically, but mistakenly) that all salaries should be classified as an administrative cost, so they report 100% of the Outreach Coordinator's salary under Management & General Expenses.
Organization B has contracted the services of a trained CPA, who knows that salaries can be divided into different categories of functional expenses. After analyzing a year's worth of payroll records, they determine that the Outreach Coordinator has spent 80% of her time interacting directly with program beneficiaries. So Organization B classifies $40,000 of her total salary as Program Expenses, and only $10,000 as Management & General Expenses.
Even after factoring in the added cost of specialized accounting services, in the end, Organization B’s Form 990 will show that they spent significantly less on overhead than Organization A. Clearly, the way you record and account for expenses can have a very real impact on the perception of your nonprofit.
Beginning next year, a new Accounting Standards Update will require all organizations to report expenses by both function (programs, fundraising, general/management) and nature (salaries, repairs, rent, postage). This is intended to make it more clear exactly how you are using your resources, providing a broader understanding of your overall financial picture on the Form 990. In theory, this may lead to greater transparency surrounding overhead expenses.
However, greater transparency doesn’t address the root of the problem. The public conversation surrounding overhead costs needs to change. Instead of rewarding nonprofits for savvy accounting skills, they should be rewarded for the effectiveness of their services and the impact of their mission. Not all organizations are able or willing to dedicate additional funds to hiring trained CPAs or researching byzantine IRS regulations. And even the most knowledgeable nonprofits are at a disadvantage in this system; after all, time is money too. Is it a good use of their time to sit down and calculate the exact cost, distribution, and departmental usage for every pencil purchased, every page printed, every phone call made? Or is it better to simply allocate the whole cost to operational expenses and move on? The more time that nonprofits are forced to spend on improving just the perception of their costs, the less time they are spending on helping their communities, assisting victims of disasters, and making the world a better place.