What is Overhead?
Based on the definitions found in the Instructions to the Form 990, a non-profit generally has three cost categories: Program, Management & General, and Fundraising. Program and Fundraising costs are relatively straightforward for any nonprofit – the costs incurred to run a specific program and money raised or donated to fund those programs (and others). Management and general costs are other costs that are involved in running the organizations on a day-to-day basis, and are often shared across multiple programs. It is with these management costs that most nonprofits find themselves in hot water with, and is often desperate to reduce or skimp out on as much as they can.
I still don’t know what Overhead means for me.
Overhead in the business sense of the word are costs incurred in the day-to-day running of the business. These are fixed expenses like payroll and rent that go out at a fixed rate every month, and variable expenses like administrative costs, marketing, printing, and office supplies that are often calculated on average per year. However, for 501(c)(3) tax-exempt organizations bound by the legal definitions of organizations that act for the public good, overhead for nonprofits are calculated a little differently. The equation is simple: adding Management expenses to Fundraising expenses, and dividing it by total expenses. Take a look at this example.
2018 Rough estimate for Nonprofit XYZ:
Program costs: $100,000
Management & General costs: $18,000
18,000 + 8,000 = 26,000
26,000 divided by 126,000 is roughly 20% – meaning that the overhead is roughly 20% of the total.
Is Overhead Bad?
Overhead gets a bad rep, mostly because of misconceptions about how funding is allocated in the nonprofit industry. However, contrary to popular opinion, industry professionals argue that organizations are far more likely to underspend than do the opposite – even when it comes to the most basic expenses like rent, utilities, insurance, administration, and accounting! It’s an inconvenient truth that often times pressure from donors or from the board to skimp on management costs often comes back to beguile them later on in the form of structural inefficiency – efficiencies that could have easily been ameliorated with the right investment in the early stages.
It’s time to rethink Overhead spending for Community Associations and Nonprofits.
What are some consequences that result from the stigma that surrounds overhead, especially for associations and nonprofits? Most have to do with the basic infrastructure on which the organization functions upon. Due to common beliefs around overhead, organizations are often kept small – limiting their access to bigger donors and more funding that can be crucial in operating a far-reaching campaign. Talented people are integral in the growth of any organization, but nonprofits that don’t look as if they offer opportunities for advancement are unlikely to attract these crowds. This double standard between non-profit and for-profit organizations that place the former at a continual disadvantage in being cheap with the basic costs that are required to run it, is what academics refer to as “The Nonprofit Starvation Cycle”.
The cycle is broken down into three vicious steps:
Step 1: Donors place an unrealistic expectation on administrators on how a nonprofit should be run
Step 2: Nonprofits feel stifled by these unrealistic expectations, and it shows in their ineffective processes, bureaucratic cultures, and limited advancement opportunities for employees
Step 3: Nonprofits respond to this pressure in two ways – by lowering their overhead, or underreporting on their operational costs. The cycle continues.
It’s time we cleaned up what the public thinks of what it means to be an effective nonprofit organization. Overhead ratio tells about 1% of the story, but the reason it gets touted so often as “the measure for success” is because nonprofits lack any other measure to judge performance. It’s therefore encouraging to see industry professionals and researchers slowly beginning to shed a light on how “the ideal nonprofit overhead ratio” is often just an arbitrary figure – a product of competition and a race to the floor on who can get it for the cheapest.
What the public perceives of your organization’s daily runnings is an important part of managing an association or a nonprofit. It’s a pressure that organizations in the not-for-profit sector uniquely face. While being careful with ensuring that funds reach the intended causes and remaining honest to the cause is what draws people to this line of work, destigmatizing spending is crucial in ensuring that this industry continues to grow and innovate going into the future.
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