The Overhead Myth: Finding Better Ways to Measure Nonprofit PerformanceBy John D'Amico | December 20, 2018
The Overhead Myth campaign, started in 2013 by Better Business Bureau’s Wise Giving Alliance, Charity Navigator and GuideStar®, aims to eradicate the practice of judging a nonprofit’s performance primarily on its overhead ratio. Instead, the campaign, which continues to build steam, advises donors to pay attention to other factors of a charity’s performance, such as transparency, governance, leadership and results. Historically, charities have been primarily judged on how much of their budget is spent on administrative over head as compared to their program expenses, and the Overhead Myth campaign has sought to change that.
“Overhead ratio” is the percentage of a nonprofit organization’s expenses that are spent on administrative (commonly called management & general) and fundraising costs, collectively called “supporting services.” It is calculated by adding administrative and fundraising costs and dividing by total expenses. The supporting services are the infrastructure of nonprofits. It might seem obvious that organizations should not be judged solely on their program/administrative expense ratio (the overhead ratio), but unfortunately, they have been, and charities have been forced to be very cognizant of what they spend administering their programs. There are numerous commercials from charities making claims such as, “Nearly 90 cents of every dollar donated goes directly to our programs,” and most of these charities’ websites make similar claims. These claims are advertised to appeal to donors, but using this simplistic ratio is a poor way to decide whether to donate to a charity and/or judge its performance.
Nonprofits are like any other business, requiring administrative costs to run. They need an Accounting/ Finance department, a Human Resources department, and an IT department. Also, a portion of the Executive Director’s salary should be allocated as an administrative expense. Fundraising expenses include any costs incurred in the process of or with the intent of asking potential donors to contribute funds, materials or time. Examples include: staff time dedicated to donor development, direct mail costs, maintenance of donor mailing lists, holding fundraising events and more. These supporting services are all necessary for the nonprofit to fulfill its mission. Low overhead costs could indicate prudence and sound judgment at a charity, but they could just as easily indicate inadequate staffing, insufficient salaries and an insufficient infrastructure. Without a proper infrastructure, a nonprofit will not be able to effectively accomplish its mission.
Until now, nonprofits were only required to report their expenses by functional category on their financial statements (Program, Management & General, Fundraising) and not by the natural categories of expenses (salaries, occupancy costs, interest, depreciation, etc.). The only way to determine what a nonprofit’s expenses were comprised of was by accessing their IRS Form 990. However, the new financial reporting requirements for non- profits as promulgated by FASB’s Accounting Standards Update (“ASU”) 2016-14 will now require all nonprofits to report their expenses by both function and by natural category, all in one place on their financial statements. This will enable nonprofits to better tell their financial stories as readers of their financial statements will now see the types of expenses that make up the organization’s program, administrative and fundraising costs.
It is encouraged that charities include a thorough discussion of all of their programs in their annual financial statements and IRS Form 990. This enables a reader of the financial statements to fully understand what the charity is doing and what they are trying to accomplish. Although not required by Generally Accepted Accounting Principals (GAAP), charities should include quantitative information about their program results in their annual financial statements as well. This information can be added to their Note 1 – Organization and Nature of Activities. Examples of quantitative program-related data that can be included in the annual financial statements are:
- Number of meals served – at a nonprofit soup kitchen
- Number of counseling sessions provided – at a victim assistance organization
- Number of homeless persons placed into temporary housing – at a social service agency
- Number of animals saved, cared for, and placed into homes - at an animal rescue shelter
When this program information is provided alongside details of the expenses that make up both program and overhead expenses, readers of a charity’s financial statements can make well-informed decisions on how a charity is performing rather than using the overhead ratio. Each of the three organizations involved with the Overhead Myth campaign offer additional information on the transparency and/or accountability of individual charities. Charities can access this information to become accredited with the BBB, grow their online identity with GuideStar and learn how Charity Navigator rates charities. For more information, visit their respective websites:
See www.give.org for information on BBB Wise Giving Alliance’s standards-based charity accreditation activities that address charity governance, finances, results reporting, transparency, and appeal accuracy among other issues.
See www.guidestar.org/update to learn about the free GuideStar Nonprofit Profiles, which enable nonprofit transparency, and empower nonprofits with Gold, Silver, and Bronze participation levels. The Gold level focuses on qualitative impact and is particularly helpful to nonprofits seeking to report meaningful results.
See www.charitynavigator.org to find out more about their star-rating charity evaluations that address charity transparency, accountability and impact.
About John D'Amico
John D'Amico, CPA, is a Director with the Professional Standards Group at Marks Paneth LLP and provides quality control services to the firm's Nonprofit, Government & Healthcare Group. He specializes in quality reviews of nonprofit organizations' audits and is part of a team that reviews all attest engagements, provides consultation on accounting and attestation matters, tests and monitors the firm's quality review policies and procedures. He also develops and delivers training material related to accounting... READ MORE +