The Overhead Solution: A New Nonprofit Pride Movement

Think of the words "overhead" and "nonprofits" and what comes to mind? Perhaps the image of inefficient organizations with layers of "fat," overpaid administrators, and wasteful spending? If so, you've fallen victim to the overhead myth.

The CEOs of BBB Wise Giving Alliance, Charity Navigator, and GuideStar USA published a second open letter last year with the express goal to "crush" the overhead myth, the idea that overhead ratios should serve as the sole basis for evaluating nonprofit performance.

While this letter is a positive step, both a panel at this year's Stronger Together Conference and follow-up interviews with the participants demonstrates that more than open letters will be needed to change the conversation around costs, impact, overhead, and mission.

First Steps: Accounting for Program Costs

If the nonprofit sector is going to change the conversation about overhead, the sector first needs to foster a more honest discussion about responsible accounting.

Hydeh Ghaffari, a partner at the accounting firm of DZH Phillips, points out the urgent need for nonprofit administrators to distinguish between and fully account for programmatic and overhead costs.

Nonprofits focus too much on where the money is coming from and report the costs against who's paying for it, overlooking the need for a more detailed, accurate examination of total programmatic and overhead costs.

For example, Ms. Ghaffari laid out a hypothetical situation: Imagine a homeless shelter funded through two contracts, one from HUD and the other from the City of San Francisco. The combination of the two contracts do not provide sufficient funding to carry out this program.

If the shelter tracks its program costs just by grant/contract, what happens to expenses that are not chargeable to either of the two contracts? Does the shelter know what the true cost of this program is?

The answer depends on the accounting and financial management expertise within the organization.

• Worst case: Where there is not sufficient knowledge, the expenses that are not chargeable to either of the contracts may land under "administration," thus increasing the overhead ratio. The shelter will lose sight of the true cost of this program.

• Best case: If the organization has knowledgeable accounting and financial management staff, those costs may be accumulated in another cost center within the program titled "other funding sources," thus allowing the shelter to keep track of both contract expenses as well as program expenses that are beyond contract funding.

These are the two extremes; there are many scenarios in between.

In an interview, Ghaffari also called out the accounting profession for not doing enough to direct nonprofits to accurately report overhead and programmatic costs: "Audit firms do not pay sufficient attention to cost allocation and assignment. Firms limit their audit of expenses to comparing current year to prior year or budget, which is customary in a for-profit environment, simply because most audit programs are not tailored to nonprofits, or auditors do not have sufficient nonprofit experience."

Accounting Resources for Nonprofits

There are numerous resources for nonprofits to access in order to learn how to accurately calculate their total costs.

• American Institute of CPAs' Accounting and Audit Guide for not-for-profit organizations
• Guidelines from the Office of Management and Budget (Circular A-122 for information on indirect costs and Uniform grant guidance for updated information on indirect costs determination)

Let's Break the Starvation Cycle

The importance of accurate reporting was also emphasized by Ann Goggins Gregory, COO of Habitat for Humanity, Greater San Francisco.

Ms. Goggins Gregory co-wrote the seminal article, The Nonprofit Starvation Cycle, highlighting the vicious cycle nonprofits face due to funders' unrealistic view of the costs to run nonprofit programs, the pressure to conform to such costs, and the resulting under-spending and under-reporting in the face of such pressure.

The article argues strongly that change begins with shifting funders' unrealistic expectations.

While Goggins Gregory still considers this a critical component, in recent conversations, she has emphasized what nonprofits can do themselves to rebalance the conversation.

• First, nonprofit leaders and funders need to publicly recognize a core truth: organizations that build a strong infrastructure and invest in maintaining that foundation are more likely to succeed than those who do not.
• Second, nonprofits need to be willing to refine their own external communications, focusing on impact and sharing stories of how lives are changed, rather than focusing on "we're lean" messaging.
• Nonprofit leaders also need the skill to calculate the full costs associated with the work they do. In so doing, organizations will be better positioned to move to a different kind of reporting, one that highlights impact versus efficiency, and one where costs per outcomes are known and shared.

"This shouldn't be controversial — for-profit spending on overhead is 25 percent across all industries and 34 percent for service industries, a closer analog to nonprofits — and nonprofit leaders shouldn't be apologetic about their capacity needs," Goggins Gregory elaborated in a phone interview. "Making this shift requires two things: will and skill."

Finally, nonprofits also need to unashamedly (even proudly!) talk about the importance of overhead expenditures within the larger nonprofit community.

A New Nonprofit Pride Movement

"We need a nonprofit pride movement," Jan Masaoka, CEO of CalNonprofits, explained in a phone interview.

Nonprofit pride means recognizing that a "no overhead" nonprofit is an impossibility, and refusing to mislead the public about not having a need for overhead expenditures.

Nonprofits can change the "overhead" conversation. For example, the Guidestar Exchange empowers nonprofits to share their own data and take control over how they tell their accounting story.

People give to nonprofits because they agree with our values. But as Ms. Masaoka explained, people are disinclined to pay administrators' salaries when a different option is presented: that 100 percent of their donations can go to feeding the hungry by organizations with little overhead.

For example, Charity Water highlights that 100 percent of its donations go to its programs. This perpetuates the myth that overhead is bad. The organization's site states that private donors cover its overhead costs, but most nonprofits cannot find such "angel" investors.

Furthermore, given how important robust, responsible spending on overhead is, a deeper question arises: what responsibility do leading nonprofits have for promoting messaging that negatively impacts the sector as a whole, reinforcing the starvation cycle?

So we return to the original challenge: can a new nonprofit pride movement change the perception of "overhead"? Our nonprofits' health may depend on such a transformation.

More Resources

• Bridgespan Group Nonprofit Cost Analysis toolkit
• Budgeting, fiscal policies, and internal control resources
• Charity Raters Part 1: Charting the Bad and the Bad
• Donor Forums' "If We Want Our Funding to Change the World" video and discussion guide for nonprofit leaders
• How to Hire a Great Accountant for Your Nonprofit from Blue Avocado
• New OMB Guidance on Overhead Costs: What It Does and Why It Matters from the National Council of Nonprofits
• Nonprofit Bookkeeping Test from Blue Avocado
• Resources for Nonprofit Financial Management from the Wallace Foundation

Image 1: The Overhead Myth / CC BY-ND

Image 2: Hydeh Ghaffari

Image 3: Ann Goggins Gregory

Image 4: Jan Masaoka

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