The Soapbox and Toolbox for New York State's Nonprofits

December 15, 2016

Understanding Overhead: A Governance Challenge for Nonprofit Trustees

Full Report: John MacIntosh, George Morris, and Dylan Roberts, Understanding Overhead: A Governance Challenge For Nonprofit Trustees (Oliver Wyman and SeaChange Capital Partners, December 2016)
 

The Nonprofit Overhead Baby and the Bathwater: A Need-to-Know for Boards

A successful nonprofit must be financially viable, deliver an effective program, and be mission-driven. When thinking of financial viability, trustees should have a clear understanding of the nonprofit’s business model, full costs, and overhead structure. Unfortunately, the last of these—overhead—is all too often seen as little more than a necessary evil to be minimized as much as possible.

We disagree. While critics of the overhead myth rightly point out that an organization’s level of overhead doesn’t say much about whether its programs are effective, a thorough understanding of overhead can suggest whether the programs, effective or not, could be delivered in a more efficient and/or stable way.1 So trustees should not hesitate to give overhead careful consideration and scrutiny alongside the other important indicators of efficiency and effectiveness.2

Trustees serious about overhead should keep in mind some important patterns highlighted by our recent analysis of the overhead of several thousand nonprofits3:

  • In every sector—from arts and culture to health and human services— nonprofits report a wide range of administrative expenses. But every sector also shows clear economies of scale, with larger organizations showing administrative costs that are significantly less (15 to 50 percent lower) than smaller organizations as a percentage of total expenses. (Three-quarters of organizations have administrative expense ratios between 8 and 19 percent.)
  • Despite all the attention they get, fund-raising expenses represent less than 10 percent of total overhead (the rest are administrative expenses) and are highly concentrated in a small fraction of organizations. In fact, almost half of the organizations— mostly very small groups or those working in health/human services with approximately 100 percent government funding—report no fundraising expenses at all. (Three-quarters of organizations have fundraising expenses between 2 and 9 percent.)
  • While fundraising ratios differ considerably by sector and size, fundraising efficiency—the amount spent versus the amount raised— varies far less by sector and not at all by size. (Three-quarters of organizations have fundraising efficiency between $0.09 and $0.29.)

Does our analysis provide sufficient information for trustees to assess their organization’s overhead? Of course not. In fact, trustees should be very wary of making peer comparisons based only on publicly available information. However, organizations that appear to be well outside the “normal” range (i.e., outside the range of 75 percent of nonprofits of the same size and sector)— should try to understand why. If costs appear low, is this a sign of efficiency, underinvestment, or poor reporting? If costs appear high, is this an inherent feature of the program, a function of organizational structure, or something else? Even if overhead appears to be in the normal range, nonprofits need to make a persuasive argument that the level of expenses is appropriate and should be funded.

In a world where overhead was viewed in the proper context, organizations wouldn’t need an overhead strategy—but in the world we live in, they do. Though nonprofit leaders are working hard to educate donors to place less emphasis on overhead, to mandate that government contracts fully fund the associated indirect expenses, and to encourage foundations to be more generous with overhead-friendly, general operating support, these efforts will take time. So, for the foreseeable future, organizations must continue to cobble together a varied portfolio of funding—high indirect-rate contracts, low indirect-rate contracts, restricted grants, and unrestricted general operating funds—to make ends meet.

Strategically, trustees should address two distinct questions regarding overhead:

 

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NYCON develops and promotes an effective and vibrant charitable nonprofit community throughout New York State.  We strengthen organizational capacity, act as an advocate and unifying voice, help to inform philanthropic giving, and conduct research and planning to demonstrate relevance and impact.