The effectiveness of a nonprofit organization is often tied to the percentage of expenses allocated to program expenses, as opposed to administrative or overhead expenses. One belief might be that the less money spent on administrative costs, the more efficient the nonprofit operates and the more resources available to the cause. However, what might this mindset cost an organization?
Many nonprofits are tasked with tackling significant, complex societal issues. To succeed, these organizations must make the same operational investments that any other for-profit business considers valuable, such as in areas of talent, training, technology, innovation, marketing and sales (fundraising), and planning for the future.
Below is an outline to help you understand the role of overhead costs and how changing the discourse about vital expenses within the nonprofit community may help your organization succeed.
Defining Overhead Costs
Overhead costs are the ongoing, necessary costs not directly tied to fulfilling the programs or services within your mission. This includes salaries and benefits for those who run the business side of operations (accounting, fundraising, marketing) as well as office space, technology, and professional services, including accounting, legal, and other consulting services. In addition, this includes costs related to fundraising in the form of newsletters, events, and direct mail. These are often referred to as general and administrative expenses, while others are classified as fundraising expenses, and are measured as a percent of total expenses.
These expenses differ from program expenses that directly tie to providing a program or service. These include program staff salaries/benefits, office space, and technology for these services.
The Art of Expense Allocation
The IRS Form 990, Return of Organization Exempt From Income Tax, and GAAP require a nonprofit to report expenses by functional classification (program, fundraising, and general and administrative).
Accounting for these allocations can be much more art than science. Costs directly tied to the program or overhead function are straightforward; salaries for program staff are entirely classified to program expenses, while expenses for an annual fundraising gala are classified to fundraising.
However, allocating shared costs such as office space and utilities is more complex. Nonprofits can select an allocation method that best reflects how resources are utilized within their organization. Some of the most common methods for cost allocations include square footage, time spent, salaries, and revenues. It is encouraged to consult with a nonprofit accounting advisor to assist with cost allocations and to help ensure compliance with accounting and IRS regulations.
Transparency & Messaging
Ultimately, the public seeks transparency on how their donated funds will be spent. Every dollar spent at a nonprofit goes toward the mission and matters, whether it is a direct program cost or an overhead cost. If a nonprofit fails to dedicate a portion of its budget to fundraising, then it won’t raise the necessary funds to operate programs. For this and several reasons, it is imperative to invest in overhead costs to help promote the long-term sustainability of a nonprofit organization.
Summary
While prevailing mindsets on acceptable overhead costs for nonprofits may be around for a while, understanding what costs are included in overhead and how they contribute to your mission will help your organization. Change the narrative and start explaining how your organization’s administrative and fundraising aspects allow your nonprofit to more effectively achieve its mission.
If you have questions or need assistance with nonprofit overhead costs, please reach out to a professional at Forvis Mazars.