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ASU Lodestar Center Blog

How does investing in overhead expenses impact the success of nonprofit programs?

overhead expenses

For several decades, overhead spending has been closely monitored as a method of evaluating a nonprofit’s effectiveness by donors, management, and charity watchdog groups. Individual funders, government agencies and foundations have used overhead ratios, the percentage of program vs fundraising and administrative expenses, as a “proxy for nonprofit efficiency”. This close focus on overhead spending has limited nonprofit advancement, harmed program outcomes, and contributed to the chronic underpayment of nonprofit employees. Overhead spending is a necessary and essential part of successful nonprofit programs. One dollar of overhead spending can increase revenue by $3.45.

Nonprofit overhead consists of finance, human resources, information technology (IT), fundraising, staff benefits, staff trainings, and part of the non-programmatic staff salaries. A common but costly misconception is the belief that all staff salaries are an overhead expense. While the bulk of admin and fundraising salaries are overhead, program staff salaries and admin staff who assist with program activities are not true overhead. Talented and dedicated staff are essential to nonprofit success as they are the first and main connection between the organization and the client. Without competitive salaries and benefits to pay staff, nonprofits will struggle to retract and retain employees and will need to utilize underqualified volunteers. IT and human resources are other essential overhead expenses that provide support to programming staff. Nonprofits need to invest in technology to stay competitive with modern times and streamline data for increasingly detailed reporting.

Donors are the largest barriers to nonprofit overhead spending with numerous studies proving that donors respond negatively to charities with high overhead. When given the opportunity to select an overhead free donation, most donors will select that option regardless of how the overhead is being spent. When choosing between covering fundraising or salary expenses, most donors will elect to fund fundraising expenses, further contributing the low salary bands within the sector.  Donor’s commitment to the cause has also been shown to impact their willingness to cover overhead expenses. High commitment donors are more willing to cover overhead as they are focused on outcomes. Low impact donors care more about the impact of the donation and feeling like their donation is directly reaching a client.

Donor pressure and an increasingly competitive market has led to nonprofits underreporting the true cost of overhead and delaying infrastructure advancements. This leads to the starvation cycle, which catches nonprofits in an inescapable loop of resistance against overhead spending.  Despite the belief of donors and some nonprofit leaders, there is an optimal level of overhead spending. Overhead spending is not a linear relationship but instead has a “curvilinear impact on outcomes”. Sufficient overhead spending allows nonprofits to build capacity in leadership and fundraising and invest in technology and staff to support programs.

Five steps nonprofit leaders can take to begin fixing their overhead issues

  1. Make a Strategic Plan for Overhead Spending and Know the Full Cost of Operating.
  2. Develop Specific Fundraising Plans for high vs low commitment donors.
  3. Stop using the overhead ratio and encourage foundation leaders to stop limiting overhead in grants.
  4. Educate donors on the importance of the administrative and fundraising departments and the essential support they provide programs.
  5. Get creative with compensation by increasing non-traditional benefits, PTO and when possible, the pay of non-executive level staff.

Overhead consists of the essential areas of nonprofit operations that provide the strong backbone for program success. Research has proven that overhead investment improves outcomes, strengthens programs and is necessary for maximal performance. The largest hurdle to overhead is donors who are unaware of the necessity and importance of overhead and are only interested in funding programs. The overhead ratio is an outdated method of evaluating nonprofit effectiveness on which many donors still rely. Nonprofit leaders and foundation leaders must work together to determine a more valid way of evaluating nonprofit effectiveness without limiting overhead spending to unrealistic standards. If nonprofit leaders and management begin by understanding and reporting the true cost of services, valuing staff wages and creating a funding plan for future overhead investments, nonprofits will be able to optimize overhead spending for the best possible program outcomes.

Marisa Pashkin is a 2023 graduate of the Master of Nonprofit Leadership and Management Program at Arizona State University. She is the Operations Manager at PAVE (Parents Amplifying Voices in Education), a parent advocacy organization that works to give parents a voice and choice the vision for education in Washington DC.  Pashkin has been working and living in D.C. since graduating from the University of Pittsburgh in 2017 and started her career as the Activities Coordinator at a medical respite facility for men experiencing homelessness. She has been working in nonprofit operations since 2018.

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