Financial Ratios for Nonprofits - The Overhead Myth

The Overhead Myth

In a huge, positive step for the nonprofit sector, the leaders of GuideStar, Charity Navigator, and the BBB Wise Giving Alliance published a letter this week calling for an end to donors' obsession with "overhead" as the dominant measure of nonprofits' worthiness and effectiveness.

I suspect most people who read this blog are aware of the overhead ratio and how it has become a yardstick for donors.  Charity watchdogs, including Charity Navigator (which has signed onto the letter released this week) have popularized the notion that "good" nonprofits spend less than 30% of their budgets on overhead, and that "bad" nonprofits spend more than 30% of their budgets on overhead.

Rather than ranting about just how wrong this is (and how unfortunate it has been that various media outlets picked up on the notion enough that it became a commonplace misconception about the sector), allow me to quote from the letter:

"[M]any charities should spend more on overhead. Overhead costs include important investments charities make to improve their work: investments in training, planning, evaluation, and internal systems— as well as their efforts to raise money so they can operate their programs. These expenses allow a charity to sustain itself (the way a family has to pay the electric bill) or to improve itself (the way a family might invest in college tuition)."

Dan Pallotta's great TED talk addressed elements of this problem (and is worth watching, even if you don't entirely agree with either the message or the messenger).  If we want nonprofits to be successful in tackling the social and environmental issues they're working on, we (as donors and supporters) need to help them succeed.  They need to be able to effectively raise money, to invest in good technology to help them better serve their constituents, to develop their professional staff to better meet their missions.  All of those things - and more - would be considered overhead costs, but without being able to make those investments, many nonprofits are stunted.  They are not able to accomplish all that we want them to accomplish, because we are implicitly telling them that we do not value -- and therefore do not allow them to make -- investments in many of the things that will help them succeed.

We at PhilanTech have felt strongly that overhead was a poor measure of nonprofit performance for a long time, so much so that we developed a financial analysis tool in PhilanTrack for Foundations (our grantmaking software) that helps grantmakers not only evaluate the impact of their grants, but also produces a series of nonprofit financial analyses that goes much deeper into understanding how organizations are performing financials.

It's going to take a while to change public perception about overhead ratios and re-train donors to think not only about administrative costs (which are a valid thing to evaluate, just not the only thing) but also about impact, transparency, governance.  And we in the nonprofit sector owe it to ourselves to help change that perception by educating our donors, our supporters, our families, our friends.

I applaud GuideStar and the Overhead Myth for taking a lead in moving this conversation in the right direction.  I signed the Pledge to End the Overhead Myth.  I encourage you to sign it, too.

Foundations - we'd be happy to show you how PhilanTrack's financial analysis tool can help you get beyond overhead ratios in understanding your grantees' financial health and performance.  Let us know if you'd like a demo.

Author: Dahna Goldstein
June 21, 2013, 11:02 AM

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