The Overhead Myth: Crash Course to Fundraising Transparency
The overhead myth refers to a pervasive practice among donors and funders of using the overhead ratio to measure an organization’s effectiveness.
Historically, organizations that spend the least on overhead are seen as the most effective. Those that spend more on overhead are seen as less effective (and may receive less support). In fact, NPOInfo’s charitable giving statistics state that a whopping 61% of donors claim to choose which nonprofits to support based on how “well” the organization utilizes its funding.
The overhead myth is a pervasive challenge for nonprofits, often leading to organizations that are under-funded, unable to make an impact that aligns with their potential, and rapidly losing high-performing employees. It’s not a new concept; in fact, as far back as 2013, GuideStar (Candid’s predecessor organization along with Foundation Center), the BBB, and Charity Navigator came together to issue a call to stop the overhead myth.
It’s been said before, and it needs to be said again: it’s time to disprove the overhead myth for nonprofits.
Explaining the overhead myth
To explain the overhead myth, we first need to define the term “overhead ratio.”
Overhead ratio essentially refers to the amount of a nonprofit’s budget that’s dedicated to overhead costs (i.e. rent, employee salaries, software licensing, energy bills, fundraising) compared to the amount dedicated to mission-specific spending (i.e. the amount of money that’s spent on direct services and programming). Donors and grant funders are able to see a high-level overview of this information in an organization’s IRS Form 990, which shows how much the organization has made and how much it has dedicated to various costs, both overhead-related and programmatic.
Some accounting methods (such as fund accounting) allocate portions of overhead to programs. And the allocation ratios can be somewhat arbitrary, making the overhead ratio a very unreliable indicator. This can also lead to allegations of “burying the overhead in mission-based expenses”. Whatever method is used, be sure it will stand up to intense scrutiny if donors dissect the accounting. It benefits your organization to always practice transparency.
Why is the overhead myth so damaging?
The overhead myth is exactly that— a myth— as overhead spending isn’t inherently bad. Nonprofits need to invest in overhead for myriad reasons, including the ability to hire and compensate staff adequately, fund basic operating costs (i.e. “keeping the lights on”), and invest in fundraising innovations that can result in raising more funding toward the mission.
Failing to adequately fund overhead can have real consequences for nonprofit organizations. Let’s consider one example— setting nonprofit staff compensation. When it comes time to cut overhead costs, some organizations start with staff salaries. After all, nonprofit employees are focus on the mission rather than salary, right? Not quite.
An article on Forbes revealed stark statistics about projected nonprofit staff turnover in the next five years, including that:
- 45% of nonprofit study respondents “indicated that they will seek new or different employment in the next five years.”
- Of that 45%, 49% said that nonprofits simply do not pay staff members enough.
This is before considering racial and gender pay disparities across the nonprofit sector. The result? A focus on decreasing overhead can lead to losing the best and brightest employees at your organization.
How can you maintain fundraising transparency and convey the importance of overhead spending?
For nonprofits, it’s time to shift the conversation surrounding the overhead myth. Instead of trying to drastically limit overhead spending or pretending as if it doesn’t exist, nonprofits need to communicate to donors that those costs are not only worthwhile, but a critical step to making an impact.
Consider these two quick tips to do so.
Set your organization up for overall financial success.
Our first tip is to set your organization up for overall fundraising stability. When your organization is raising enough money to not only cover overhead expenses but also have a significant impact on your cause, it will be hard for donors to doubt your effectiveness.
Keep the following suggestions in mind to create a strong financial foundation for your nonprofit:
- Plan a robust fundraising calendar that incorporates both online and offline strategies.
- Work with a nonprofit accountant to create an ironclad budget and stick to it.
- Invest in online donation tools both to appeal to supporters and add efficiency to your fundraising efforts.
Go above and beyond with transparency when discussing overhead.
Nonprofits currently provide financial information to supporters via the IRS Form 990. Consider taking your nonprofit’s financial transparency a step further and providing additional spending information to supporters. The goal should be to add nuance to your nonprofit’s spending, showing supporters that overhead spending is truly important.
A 2018 study supported this idea after it showed that nonprofits that achieved the GuideStar (now Candid) Seal of Transparency “averaged 53% more in contributions the following year compared to organizations that didn’t earn a Seal.” Nonprofits can earn a Candid Seal of Transparency by sharing information beyond what’s on a 990, including programs, staff demographics, equity strategies, goals, and more.
While discussions of overhead shouldn’t be your nonprofit’s focus—rather, impact should—your supporters will appreciate having this information.
The nonprofit overhead myth is a pervasive challenge, causing both external and internal limitations on a nonprofit’s finances. However, overhead is an essential component of any nonprofit’s ability to advance its mission— let alone keep the doors open.
The best ways to combat the overhead myth are to run an undeniably effective nonprofit and practice radical transparency with supporters.
One might also consider developing an earned income stream, which produces unrestricted income and reduces dependency on the eccentricities of donated income.
Learn more about all aspects of nonprofit accounting by attending the Accounting for Time & Money class on Saturday, November 19 at 1 pm as part of the Sunshine Certificate in Nonprofit Management.
Source: Candid blog. Candid has been a preferred partner since 2018 when Florida Nonprofits became an outlet for the Foundation Center Funding Network.
Author: Jacob Spencer, Customer Success & Account Manager, Donately