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Overhead Costs Too Low, You Say? Watch Your Mouth!

(July 28, 2008) Much has been made of fundraising costs and the overhead expenses of nonprofits. There are percentages thrown about and charities measured and judged based on these numbers. But if you have an “acceptable” or “good” ratio of money going to programs versus overhead, is your organization really better off?

An analysis by The Bridgespan Group argues that strategic and proper investments in overhead are necessary for growth and sustainability—and they say such expenditures, be they in human resources or technology, are often going to break the so-called “acceptable” overhead-to-program ratios.

Bridgespan’s report, titled Nonprofit Overhead Costs: Breaking the Vicious Cycle of Misleading Reporting, Unrealistic Expectations, and Pressure to Conform points to research that shows overhead costs are often underreported by charities, from what they tell donors to what they report on their Form 990.

Bridgespan cites the 2004 Nonprofit Overhead Cost Project conducted by The Urban Institute’s Center on Nonprofits and Philanthropy and The Center on Philanthropy at Indiana University to show that underrepresentation of overhead costs is common. Bridgespan’s analysis argues that such reporting is part of a vicious cycle wherein charities feel pressured to show small overhead rates and people expect charities to have such unreasonable, or even implausible, ratios.

In the Urban Institute/Indiana University 2004 study, researchers looking at the tax forms of 220,000 organizations found “widespread reporting that defies plausibility.” They found that over a third of organizations reported having no fundraising costs whatsoever, while one in eight reported having no management and general expenses.

Bridgespan argues in its report that overhead costs, first of all, should be defined more clearly—to include all fundraising and administrative costs as well as marketing and communications costs. They say this of the dangers of the underreporting cycle:

“As unrealistic overhead expectations place increasing pressure on organizations to conform, executive directors and their boards can find themselves under-investing in infrastructure necessary to improve or even maintain service-delivery standards, particularly in the face of growth. In the short term, staff members struggle to ‘do more with less.’ Ultimately, it’s the beneficiaries who suffer.”

Making the Case for Overhead

The report offers the following suggestions to nonprofit leaders to alleviate the pressures to shrink overhead expenditures and show how the organization would benefit in the long term—even save money—with better infrastructure and human capital.

  1. Develop a strategy that explicitly recognizes infrastructure needs. Framing strategy discussions around goals and the investments needed to achieve them can be more effective than centering such conversations on costs.
  2. Communicate the logic for increased overhead investment throughout the organization, and to the board. A collective commitment from all levels of the organization, including senior staff and the board, is a powerful lever.
  3. Begin to provide funders with better ways to measure performance than program ratios. A conversation about costs to achieve outcomes (and how investments in overhead can reduce those costs) can be much more meaningful.

An Impact Focus

Finally, Bridgespan suggests creating an “impact culture” that focuses on measuring and disseminating data on outcomes of a charitable organization’s programs. As the report notes, “A conversation about costs to achieve outcomes (and about how investment in overhead can reduce those costs) can be much more meaningful than one that centers on program ratios.”

The Bridgespan Group synthesized existing research on nonprofit overhead costs, conducted interviews with a range of nonprofit managers, and examined four nationally-recognized youth-serving nonprofits in depth to inform its report, issued recently. The report is available here free of charge.

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