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The Cost of Doing Business: Overhead is key component of meeting nonprofit mission

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Giving season is on the horizon. Giving Tuesday, the first Tuesday after Thanksgiving, kicks off a month in which nearly a third of all charitable donations are made.

In 2021, Philanthropy News Digest reported Americans donated $2.7 billion on Giving Tuesday, a 9% increase from the previous year. However, donor management software firm Kindful reports Dec. 31 is the biggest giving day of the year.

Not-for-profit organizations large and small count on end-of-year giving as a key form of support for their operations, when many taxpayers are eager to maximize their tax deductions through charitable donations.

But of the 1.4 million charitable organizations in the U.S., which ones merit a donation? For years, one factor was considered above all others by charity rating organizations: the percentage of its budget going toward overhead.

Overhead is the portion of an organization’s budget directed toward administrative or fundraising costs as opposed to programing. Some evaluators, like Charity Watch, still factor overhead percentage heavily into their ratings. Charity Watch’s gold standard of “highly efficient” is awarded to organizations that spend 25% of their budget or less on overhead and spend $25 or less to raise $100.

Nearly a decade ago, three groups, Charity Navigator, GuideStar and the Better Business Bureau’s Wise Giving Alliance penned an open letter to the nation’s donors. In it, they announced their view that the percentage of expenses that go to administrative and fundraising expenses are an incomplete measure of a charity’s performance.

“In fact, many charities should spend more on overhead,” they wrote in 2013, noting that overhead can include investments in training, planning and evaluation. “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).”

Donors may have found comfort in having an objective measure like percentage of overhead to judge a charity. Without it, they are left to do a trickier calculus, and some may wonder how to decide on which not-for-profit to support.

Nonprofit as a business
Dan Prater, a senior managing consultant in nonprofits for FORVIS LLP, said nonprofits are widely misunderstood.

“One of the misconceptions is that nonprofits don’t operate like a business,” he said. “That’s actually not true. Nonprofits are a business; they are just in the business of helping people, and they happen to have a tax-exempt status.”

Prater said some rating organizations continue to apply a standard for program efficiency ratio, calculated by dividing program expenses by total expenses. Despite how they broadened their lens, Charity Navigator continues to prize an 85% program efficiency ratio. The Better Business Bureau has a lower standard at 65%, he said.

“I agree that it’s important for organizations to use their money on accomplishing the mission,” he said. “That’s the bottom line: If they have a clearly stated mission and they’re addressing a legitimate need – environment, children, social injustice of some kind – it’s important that the organization is really doing something to better or improve that situation.”

Prater said a nonprofit’s mission is its promise to donors and the community.

“The reality is that there is a very real cost to delivering on this promise,” he said.

Prater said an organization needs to attract and retain happy employees and operate in a clean, functional facility with sufficient technology. Other expenses include accounting, insurance and other management needs.

“That’s where we run into problems,” he said. “The word overhead itself has implications. It implies waste.”

But those expenses are not waste, Prater said.

“It’s time to set the record straight: Paying men and women who deliver programs to the community is not waste,” he said. “It’s time to stop identifying those expenses as optional, or as wasteful that anybody would dare use them.”

The real measure of success is moving the needle on the problem a charity is addressing, he said.

“I don’t care if you have a 40% ratio; if you’re improving lives, that is a success,” he said.

Shelly Drymon, development director for The Summit Preparatory School, agrees.

In October, Drymon wrote a LinkedIn post expressing her disappointment with an unidentified organization that had hired the 26-year nonprofit professional as director of development six months previously, only to have them eliminate the position to reduce their overhead.

“There’s a perception in the community that people go into not-for-profits because it’s a passion, which is true. But the thinking is that we do it out of the goodness of our heart, so money shouldn’t matter,” she said.

Just check an organization’s federal form 990, Drymon said.

“You’d be shocked at what executive directors do not make here in Springfield.”

But it’s not a Springfield problem, she noted.

“I think it’s an industrywide issue,” she said.

Drymon agreed with Prater that nonprofits are businesses.

“I don’t eat at McDonald’s, but I’d never question McDonald’s marketing costs and overhead,” she said. “We need to start looking at funding the fundraising and development department so they have the resources they need to raise more money.”

Evaluating nonprofits
Brian Fogle, president and CEO of Community Foundation of the Ozarks Inc., said assessments by rating organizations are worth a read, especially since some organizations exist to take advantage of people.

“There’s just a lot of solicitation – on the phone, by mail, etc.,” he said. “I think we have to be very careful in responding and being able to tell the caller, ‘I need to do a little more research.’”

But mainly, Fogle suggests donors look close to home for organizations whose work they can see around them, and whose volunteers, board members, donors and target population are people they know.

“We’ve got a strong nonprofit community,” Fogle said of the Springfield area. “Any number of those, you could call them and say, ‘I’m thinking of donating; could you tell me a little bit more about your organization?’”

Greg Burris, president and CEO of United Way of the Ozarks, said there are 1,500-2,000 local nonprofits, and his organization has a team of donor volunteers to vet their financial statements and make sure they are serving their intended purpose.

“We always encourage people to look to their heart,” he said. “What is it they’re passionate about?”

People who are confused about their options should consult an expert, he said, just as they might consult an investment manager if they wanted to build their wealth.

“That’s part of what we do for the community,” Burris said of United Way.

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