The overhead myth
Accounting standards require tax-exempt nonprofits to report their expenses in three categories: program, management and fundraising. Charity rating systems take this data from Form 990 (the nonprofit’s annual IRS reporting form) and use it to rate an organization’s effectiveness based on an overhead-to-program ratio.
After decades of using that ratio, in 2013 the CEOs of three of the leading charity rating businesses (GuideStar, Charity Navigator and BBB Wise Giving Alliance) co-authored a letter stating: “The percent of charity expenses that go to administrative and fundraising costs – commonly referred to as ‘overhead’ – is a poor measure of a charity’s performance. We ask you to pay attention to other factors of nonprofit performance: transparency, governance, leadership and results.” Some rating systems are now adding other information to their rating criteria.
Unless an organization is all volunteer, no office, no insurance, no training budget and no copy costs, it probably has overhead. An organization may have fee-based programs or sponsors covering the expenses of management and fundraising so contributions can be channeled exclusively to programs, and that’s great. However, trumpeting low overhead numbers as a sign of quality is misleading when research actually shows we can starve nonprofits of needed infrastructure when overhead is too low. It is an outrage when nonprofits pay exorbitant salaries and dedicate only pennies for programs, but it is time to recognize the overhead pendulum can swing too far in both directions.
It takes money to make money, and durable infrastructure (technology, staff, professional services, training) is essential to support robust programs as well as to steward funds. If you want accountability, someone needs to pay for the accountant. Greater transparency and donor education on the true costs of providing valuable programs help nonprofits more than subscribing to the notion that the 1.6 million U.S. nonprofits can get everything they need donated.
If trim, strategic overhead is an accepted cost of doing business, how do we measure nonprofit effectiveness? Largely by painting a picture using a variety of admittedly imperfect metrics:
Inputs: Quality ingredients
Nonprofits can detail the resources they put together to conduct their activities such as donation levels, grants, volunteer time, staff expertise and board experience. These ingredients tell us that a group is active, and that others believe in them and are invested in their success.
Outputs: The proof is in the pudding
Almost every group quantifies their activities: people fed, children graduated, patients seen, concert seats filled. Savvy donors know that some programs work intensely to change the lives of a target population, whereas others offer a simpler but important experience to many. Outputs are interesting, but still don’t tell us about program quality.
Outcomes: The nutritional analysis
The most in-depth assessments tell us if clients are better off after participating. Sometimes results can be clearly measured when nonprofits have invested in program evaluation. Others draw from academic studies to state their value. You may pooh-pooh research that states the seemingly obvious (e.g. it’s healthy for children to play outside), but some outdoor youth programs benefitted from studies that quantified the value of play. Many nonprofits are focused on a long arc of change, and studies following participants over years are generally only practical or cost effective for groups receiving large multi-year grants.
Effective nonprofits use all of these tactics, seeking to increase their insight into outcomes as that field advances and offers more practical and affordable options. Most nonprofits also use meaningful stories to better articulate the benefits of their work.
When selecting where to donate, think high performance, not low overhead. High performance is visible in a variety of ways, while low overhead viewed in isolation can mask organizational shortcomings.