(Mis)Understanding Overhead

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Your nonprofit’s mission matters. And it costs something to deliver it! Enlightened donors and grantmakers recognize that administrative costs (called “indirect costs” when government dollars are involved) are essential in order for charitable nonprofits to be financially sustainable, but for too long, “overhead” has gotten a bad rap and been inappropriately used as a measure of a nonprofit’s effectiveness. The assumption that overhead is “bad,” reflects a mis-appreciation of the reality of what it costs to deliver a nonprofit’s mission.

Views of Overhead are Changing

The belief that overhead is negative is changing. Indeed, more people are realizing that costs may have nothing to do with how effective a nonprofit is. In fact, overhead that is too low is more concerning as it relates to effectiveness. Instead the focus is shifting toward a nonprofit’s impact and effectiveness. It is our hope that everyone who invests in a charitable nonprofit’s mission – the staff and board of a nonprofit, as well as individual donors, businesses, private foundations, and government, become aware that operating a charity is not free (gasp!). It costs something to deliver a nonprofit’s mission.

What is "overhead?"

Overhead is generally defined as a combination of “management,” “general,” and “fundraising” expenses. There are definitions found in the Instructions to the Form 990.  Based on the 990, a nonprofit has three categories of costs: Management & General, Program, with Fundraising. Management & General plus Fundraising making up overhead costs. Program Costs: The costs incurred in connection with a specific program or activity of the organization. These are the costs often referred to as direct costs. Note: Some nonprofits have only one program, others many.

Fundraising Costs: Costs that involve seeking, soliciting, or securing charitable contributions. Examples: development staff, the fees paid to a fundraising consulting firm, and the fees paid to register the charitable nonprofit for solicitation purposes preparing grant proposals.

Management and General Costs: All the other costs that are needed to operate the organization and are shared across programs.

What is Overhead? (CalNonprofits' Overhead Project)

For grantmakers and donors: If we want our funding to change the world... (Video by Forefront)

Practice Pointers

  • Note that for those nonprofits that file the IRS Form 990, they will have to report “management and general” separately from “fundraising” expenses. (See Instructions to the Form 990 at page 42.) The practical effect of this is that any charitable nonprofit that files the IRS Form 990 (as opposed to the 990-EZ or 990-N) is required to report its fundraising expenses annually to the IRS.
  • Costs are Cool: the Strategic Value of Economic Clarity, stresses the importance of resource allocation, the need to identify full costs as part of that analysis, and offers a full explanation of “full costs.” (Bridgespan)
  • Both the IRS and FASB (Financial Accounting Standards Board) have definitions for functional expense classifications that are not always consistent with each other. Every nonprofit needs to use judgment and may need professional assistance, such as from a CPA, to sort out the appropriate allocations of costs. Overhead Costs Definitions can help. (Nonprofits Assistance Fund)
  • More and more nonprofits, joined by enlightened grantmakers, are comfortable with the reality that costs – whether referred to as “overhead,” “management and general,” “administrative,” or “indirect costs” - are essential to their ability to advance their missions. But, in order to maintain the donating public’s trust, it’s important to be transparent about your nonprofit’s finances and also the outcomes of your nonprofit’s activities.
  • Learn more about how to #OwnYourOwnCosts.
  • Help foundations recognize that 69 percent of foundations support paying nonprofits' administrative costs. See “Paying for Overhead.” (The Center for Philanthropy at Indiana University).

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