Two years ago a TED Talk by Dan Pallotta reverberated across the country, starting a movement to change the way many people viewed the administrative costs of nonprofit organizations.
Also in 2013, the leading sources of information on nonprofits — GuideStar, Charity Navigator and BBB Wise Giving Alliance — wrote a letter to donors, as part of an overhead myth campaign.
“There’s this stigma,” says Ellyn Lefko, CPA, assurance manager at BDO USA LLP. “Donors want to believe that they are giving their money to the cause. They forget about the fact that helping the cause doesn’t exist if you don’t have the infrastructure throughout the organization to deliver that mission.”
Smart Business spoke with Lefko about whether administrative costs are a bad thing when it comes to nonprofit organizations.
What do administrative expenses for nonprofits typically include?
These are whatever costs are necessary to run the organization that aren’t program related. It’s the general infrastructure, such as the back office staff, IT set-up, training, leadership development, strategic planning, marketing, PR, etc.
Why has overhead been viewed so negatively by donors?
Nonprofit organizations are required to show on their Form 990 how they allocate administrative, fundraising and program expenses. Donors look at that and ask, ‘How much of the dollar that I give is going to directly help the children or feed the hungry?’ They often judge the organization by the overhead ratio — the percentage of administrative costs out of the total expenses the nonprofit has for the year.
How did the TED Talk and the overhead myth campaign address this issue?
The example in the TED Talk* was that you could run a bake sale and earn $75 for your nonprofit with no overhead. Or you could spend $200 on a radio ad campaign, reach more people and bring in $500 while also having the benefit of increasing your exposure and donor base. Why is it wrong to spend more if you end up better off?
The CEO of a corporation makes six or seven figures, but the CEO of a hunger charity is scrutinized if he or she makes $80,000. How can a nonprofit get the best talent that can execute new strategies if it cannot pay market salaries?
If the organization doesn’t pay for good accounting staff, it won’t have adequate controls and fraud is more likely to occur. If there’s turnover year after year, the nonprofit will be playing catch-up and the records won’t be in order. If the IT system isn’t up to date, computers could consistently crash.
It’s a penny-wise, pound-foolish mentality. Are you really doing what’s best just because you want donors to believe that every single dollar goes to the mission? The mission isn’t there without the overhead.
How should nonprofits and their leadership find the right balance of expenses?
It can be difficult, but investing in the overhead can enable nonprofits to reach more people, and be more effective and efficient. Therefore, the organization needs a good understanding of its true costs, so it can try to be consistent and appropriate in how it allocates funds.
The leadership also needs a clear idea of the nonprofit’s goals and what it will take to achieve those goals. If you’re building a new facility that will further the mission, the administrative costs will go up significantly — but it’s not necessarily a bad thing in that scenario.
Donors may be concerned with expenses and overhead, so be transparent and educate them. Instead of only looking at the overhead ratio, encourage them to ask different questions. What is the effectiveness of your organization? How efficiently do you carry out your mission? How many participants did you reach?
Just like in corporate America, the nonprofit needs to consider ROI and value. Look at your fundraising efficiency. How much does it cost you to raise a dollar, and how successful are you in doing that?
This doesn’t mean administrative costs should run amuck, but it can mean taking on a different mindset at what the nonprofit potentially loses by focusing so tightly on overhead costs.
*To learn more about the overhead myth, visit http://overheadmyth.com or www.ted.com/talks/dan_pallotta_the_way_we_think_about_charity_is_dead_wrong.
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