Jackie Cefola Consulting

What is nonprofit overhead? 

Nonprofit overhead is described as non-program-related expenses. If an organization files an IRS Form 990, the overhead rate is the sum of reported management and general and fundraising divided by total expenses. 

Many have previously explained why the concept of nonprofit overhead is highly problematic.[i] As we discussed last month, the idea of nonprofit overhead creates an unhealthy distancing between mission-related activities and the supporting activities that sustain the organization, as if the mission could be fulfilled without an organization driving the effort. 

Nonprofit overhead can also be hard to measure. Overhead is not always defined by job title or by job task. Most nonprofit organizations have budgets under $250,000 and a small staff who always work on everything and take on multiple roles. Many activities blur across the lines of programmatic and non-programmatic categories. Most organizations do not have sophisticated cost accounting or strict time tracking procedures in place. Hours spent on overhead tasks are estimated as best as possible.

Yet there is a need to track and report out operational performance metrics and, for now, the overhead rate continues to be used for evaluation:

  • Charity Navigator’s Financial Efficiency Performance metrics include ratings based on programmatic, administrative, and fundraising spending. For “general and grantmaking organizations,” a top rating goes to groups with non-program spending under 15%. 
  • Donor Mindset Study reported that the average US donor believes, across the board, that nonprofit overhead should not exceed 19%. 
  • Public and private funders also often set overhead limits, often 10 to 20% of overall spending. 

These overhead rate guidelines and limits are applied to nonprofit organizations regardless of many factors that influence operational expenses, such as mission, programs, budget size, geographic location, staffing model, need for research/development, and lifecycle of the organization. 

Why are navigators, funders, donors, and the public in general so keen to set nonprofit overhead rates? And why are higher overhead rates considered to be bad? 

We suspect that the setting of overhead rates relates to a common but mis-held belief that nonprofit organizations are inherently inefficient and wasteful because they are not influenced by supply, demand, competition, and other market factors in the same way that for-profit businesses are. How many times have we heard the call for nonprofits to act more as businesses? 

But if nonprofits really acted more as businesses, there would be room to invest in overhead. In the for-profit sector, overhead rates are understood to vary by industry and absolutely exceed 19%. In one study, small business overhead rates reportedly ranged from 36% (clothing stores) to 73% (child day care services).[ii]

Somehow a higher overhead is acceptable when the goal is to generate profit but not when the goal is to create mission impact – even when the mission is required to combat market failure. 

We also think the drive to minimize nonprofit overhead rates implies a lack of trust in nonprofit leadership. The setting of an overhead rate limit is like the setting of an allowance, or a parental guardrail. The implication is that a spending limit is needed because executive directors lack knowledge, skills, and experience and cannot be trusted to develop operational strategies that best serve their organizations without significant guidance. 

Given all these pressures and perceptions, it isn’t surprising that nonprofit leaders are primed to reject strategies that could potentially increase overhead, even temporarily. Couple this with the need for greater funding of high quality nonprofit operations and it becomes clear why there is such a strong drive to minimize overhead.

How can we move beyond the drive to minimize nonprofit overhead and allow for more sound operational management and organizational health? 

What if instead of focusing on overhead we asked, “how much are we spending on operations and why?” What are the true costs of programs and operations? We’ve seen more than one nonprofit organization, to minimize overhead, not recognize that their business model relied on taking high operational risks, burning out staff, not staying in compliance, or not allocating for a reserve fund. There is a need to measure and communicate nonprofit health more completely and with a mindset that values proactive and long-term strategy, including investments in operations.

What if we trusted nonprofit leaders to be capable of making the right decisions and requests for their organizations, including decisions to invest in overhead? Imagine a relationship where nonprofit leaders are trusted to make the right programmatic decisions and can also be trusted to make the right operational choices. It is exciting to see the emerging body of work around “trust-based philanthropy.” The Trust-Based Philanthropy Project created an initiative to make trust-based practices the norm in philanthropy through peer-to-peer learning and advocacy. 

Overall, funders, donors, nonprofit leaders, the public must build support for nonprofit organizations to spend an appropriate amount, not a minimal amount, on the operations needed for effective and impactful programs. 

Together, we must move beyond overhead limits and allow for the possibility that higher operational costs are sometimes necessary for long-term stability, compliance, growth, and innovation.

This article is the third in a series, based on conversations between Jackie Cefola and Debra Box about nonprofit shared services and related topics. 

Jackie Cefola, principal of Jackie Cefola Consulting, is a trusted advisor to nonprofit leaders who are starting up new collaborations, often related to shared services. Debra Box, principal of In the Box Consulting and former President and CEO of Support KC, where she helped nonprofit organizations to focus on their missions by providing integrated expertise in financial management and support services.


[i] Vu Le, “How the focus on overhead disenfranchises communities of color and fans the flames of injustice;” Curtis Klotz, “A Graphic Re-visioning of Nonprofit Overhead;”  Ann Goggins Gregory & Don Howard, “The Nonprofit Starvation Cycle

[ii] https://www.washingtonpost.com/wp-srv/special/business/costofrunningabusiness.html

When we talk about the potential for nonprofit organizations to engage in shared back-office services, including fiscal sponsorship, joint contracting, MSOs, or other collaborative strategies, we often hear that the concepts are attractive but… before these strategies can be considered, there needs to be more funding to pay for high-quality operational services. 

We think that the lack of funding for nonprofit operations is influenced by history. Early nonprofit-type organizations in the US were founded by religious institutions, civic campaigns, community associations, and memberships involving charity, education, service, activism, and social activities. Groups were volunteer-led and not recognized as independent legal entities. These historic concepts of charity, volunteerism, and informal work still influence how nonprofits are perceived, namely that nonprofit organizations are somehow not “real” or deserving of high-quality operations.

We see a related push for nonprofits to run their operations “more as businesses,” implying that for-profit operations are more effective than mission-based operations. For example, common funding proposal questions read like sections from a business plan, including:

  • What is the proposed service and what is your competitive advantage?
  • Who is your client or customer and how many will you reach?
  • What is your sustainability plan? What is your earned income? What are your other sources of funding? 

Here’s the disconnect. Unlike business plans, nonprofit funding proposals usually do not require an operations plan with information about organization-wide functions, such as accounting, data management, compliance, insurance, professional development, purchasing, communications, human resources, or facility management. We suspect that an operations plan is not required because many funders seek to fund specific program activities and not general operating, start-up, capital, or overhead. It is also common for nonprofit funders to limit indirect expenses to a set percent of program expenses, regardless of the mission and administration involved. 

Despite the expectation for nonprofits to be more business-like, it’s as if the operational functions, what makes the nonprofit an organization, aren’t as important when compared to funding the direct costs of programs. As if programmatic impact can happen independently, almost magically, without:

  • High-quality, stable, and compliance-oriented operating systems
  • A knowledgeable team of professionals and board members
  • Appropriate workspace and supplies
  • Funding for startup, growth, and emergencies
  • Research and development for future proactive strategies

Yet we know, especially now, that this is not how effective organizations, whether for-profit or nonprofit, operate. The COVID-19 pandemic has shown us that high-quality operational practices are necessary for organizations to adapt to unexpected situations, provide essential goods and services, and offer stable employment in times of stability and in times of crisis. 

The pandemic has also shown us that a new prioritization of nonprofit operations is possible. In 2020, we saw a new immediacy and acceptance for nonprofit organizations to discuss operational challenges with funders, including challenges that were persistent. More funders offered unrestricted funding and engaged in collaborations to share information and collectively support emergency response and capacity building. New shared service networks started up and new fiscal sponsors began offering services to support increased demand.

Adding to this momentum, we believe there is new financial capacity to support nonprofit operations. Because, despite the pandemic, investment returns were high, wealth grew, and as a result, funding institutions have more to give. There is potential to increase unrestricted, general operating, capital, and multi-year funding without taking away from existing programmatic priorities. 

With these trends in mind, we hope that nonprofit operations will become more of a priority and that nonprofit organizations will have the resources needed to access high-quality back-office services. As this support and recognition of the need for nonprofit operations grows, we also hope that more organizations will be able to explore the potential for shared services and not miss out on opportunities due to a lack of funding.

This article is the second in a series, based on conversations between Jackie Cefola and Debra Box about nonprofit shared services and related topics. 

Jackie Cefola, principal of Jackie Cefola Consulting, is a trusted advisor to nonprofit leaders who are starting up new collaborations, often related to shared services. Debra Box, principal of In the Box Consulting and former President and CEO of Support KC, where she helped nonprofit organizations to focus on their missions by providing integrated expertise in financial management and support services.

Nonprofit operations may not seem sexy, but they are key to building capacity and resiliency. And what’s really not sexy is a nonprofit organization with outdated systems that cause inefficiency or non-compliance; or practices that contribute to someone’s burnout.

During a recent a presentation about shared services someone asked, what’s sexy about nonprofit operations and why should we pay attention?

Admittedly, when you first learn about a nonprofit organization, the mission is probably what sparks your interest. The back-office of an organization, the accounting, finance, information technology, human resources, and other administrative services, is not as immediately eye catching. Yet we know that these functions are essential. 

In a recent conversation, an Executive Director of a newly forming nonprofit recognized the need for operational support. “My Board wants me to focus on the strategic direction of the organization and not on administrative tasks, but right now there is no one else to do them. In the short-term, board members will be supporting in these areas. Board members that have been recruited have skills that are needed.”  

More resources exist for for-profit startups. When an entrepreneur starts a small business, there are public structures to provide consulting, support, and resources to help set up effective operations, including through the Small Business Administration (SBA). While nonprofit entrepreneurs can utilize and adapt the SBA’s services, there is no dedicated Small Nonprofit Administration, despite the reality approximately 2/3 of nonprofit organizations that report any expenses have budgets under $250,000 per year. 

A $250,000 nonprofit budget typically translates to an organization with a staff of one or two people who are responsible for all operational functions in addition to mission-related activities. In practice we frequently see an executive director who is responsible for accounting, finance, information technology, human resources, and marketing – in addition to leading programs and services. 

This increases organizational risk because no one person can be exceptional at every operational and programmatic function. There may be gaps in service quality if, for example, best practices are not followed, or systems are not updated. This also can contribute to leadership burnout because it is very hard to balance so many competing priorities and also have very little capacity to consider alternative ways of doing things. 

The founder of a 5-year-old environmental group recognized the need for operational planning, budgeting, and funding as she looked back on her experience, “I created a business model that never included staff and I’m paying for that now. I took classes to build my skills, but I did not want continue to do everything.”

Maybe our interest in operations is changing. Over the past year the COVID-19 pandemic caused many nonprofit organizations to pivot. Funders had a choice about what to do when funds were allocated for programs that couldn’t be provided as proposed. Some funders responded by allowing organizations to re-purpose funds to make operational investments, for example, to support technologies and systems for remote work.

National networks and local networks also offered new ways for nonprofit leaders and back-office service providers to share information and best practices, for example, to help organizations navigate the PPP loan application process. 

Outsourcing and shared service providers, including fiscal sponsors, continued to offer different collaborative back-office services to suit the needs of nonprofit organizations. 

Looking forward, as nonprofit organizations transition back to the workplace, we suggest that the back office must continue to be a priority. As we’ve learned over this year, an organization’s operations can strengthen stability, resilience, and responsiveness and when we invest in the back office, we increase overall capacity for mission impact.

 

This article is the first in a series, based on conversations between Jackie Cefola and Debra Box about nonprofit shared services and related topics. Jackie Cefola, principal of Jackie Cefola Consulting, is a trusted advisor to nonprofit leaders who are starting up new collaborations, often related to shared services. Debra Box, principal of In the Box Consulting and former President and CEO of Support KC, where she helped nonprofit organizations to focus on their missions by providing integrated expertise in financial management and support services.

This week I had the opportunity to co-facilitate a virtual “Lunch and Learn” session with the MetroWest Nonprofit Network. My co-facilitator, Andrea Shapiro, and I reviewed a basic framework for thinking through very complex decisions involved with returning to the workplace. We suggested three areas to explore:

  1. The current situation, what strategies are working now and should continue
  2. Strategies for increasing safety, health, comfort and productivity while returning to the workplace
  3. Potential long-term impacts to the workplace and to the organizational budget

We also spoke about the need to engage staff in these conversations with the aim to build communication and trust during these challenging times. See the recent article that Andrea and I wrote with a list of specific questions to help start the conversation.

Andrea and I were excited to connect with MetroWest nonprofit leaders and we look forward continuing to develop resources to support organizations during this time of transition.

I recently contracted with the Nonprofit Centers Network to help a capacity building organization in Philadelphia understand the local demand for shared services.

We started by asking how groups currently access, or in some cases don’t access, back-office services, for example, accounting, marketing, fundraising, information technology, and human resources. We also asked which, if any, of these functions felt particularly challenging, and why. We then explored whether groups would potentially be interested in developing new shared service strategies, for example, shared staffing or joint contracting.

I understand that for many, researching this back-office stuff may not interesting or “sexy” (look for more on this point in the future) but to me, decisions about operational functions directly reflect an organization’s culture, priorities, and overall health. Furthermore, groups that seek to collaborate and strengthen back-office services are doing so to increase resilience and ultimately mission impact.

All to say, I was really excited to better understand opportunities for shared services in Philadelphia and I look forward to staying in touch as efforts progress.