**Now more than ever, as the call to achieve high standards of outcomes-based measurement grows, we must hold ourselves to an equally high standard of understanding nonprofits’ full costs. This article is meant to encourage nonprofit executives and boards to know and advocate for their full costs, and to urge the philanthropic sector to structure funding with greater consideration for the full context in which its grantees are operating. We look forward to the day when nonprofits and funders have embraced the concept of full costs, which include far more than direct program expenses and so-called “overhead.”
Overhead as a Parental Control
Many foundation leaders now understand that overhead is part of the real, necessary costs of delivering quality programs. Funders large and small have shifted grant strategies to fund overhead. In 2013, Charity Navigator, GuideStar, and the BBB Wise Giving Alliance spoke out against the myth that overhead spending is a meaningful way to evaluate nonprofit performance.1 Even the federal government, at the end of 2014, began requiring federal grants to cover nonprofit overhead costs.
Yet, it seems practice is lagging behind public discourse: In Nonprofit Finance Fund’s Annual State of the Nonprofit Sector Survey 2015, only 7 percent of nonprofits report that foundations always cover the full cost of the projects they fund; while decrying the overhead ratio as a “poor measure of a charity’s performance,” Charity Navigator still includes the overhead ratio as the very first financial performance metric in its evaluation; and the federal government set a pitifully low default overhead reimbursement rate of 10 percent. In other words, funders and watchdogs (and probably even nonprofits themselves) are not “there” yet in recasting overhead as an essential cost of providing services—and we have farther to go than you might think.
Imagine if your personal paycheck were like a restricted grant. Instead of representing your value and level of responsibility in the company, your paycheck is based on a predetermined line-item budget that details exactly how you can spend your earnings. A portion of your paycheck can be used for rent, some for utilities, but most is earmarked for business attire, transportation to work, and coffee to keep you productive throughout the day. The thinking here is that by tying your paycheck to the expenses that contribute to your work, the company is making sure that you will show up on time, appropriately caffeinated, and properly dressed. It’s as if every penny of your paycheck is spent before you cash it.
To some extent, you had a say in your paycheck budget. In fact, you had to present a proposed paycheck budget when you applied for the job. Your friends on the inside said no one who spends more than 20 percent of his or her paycheck on rent has ever been hired. To get the job, you cut your rent line item. That means making do with an efficiency unit above an all-night bowling alley, but it’s better than not having a job at all. Some line items were nonnegotiable from the start: As a policy, your company won’t pay for haircuts; but that’s okay—you can let your hair grow long.
At the end of the year, the company assesses your job performance by comparing your actual spending to the line-item budget. Your spending is carefully scrutinized for fluctuations of 10 percent or more, and your job is in jeopardy if it fluctuates too much. You know this measuring of line-item expenses doesn’t say much about the value you created for the company. You are pretty certain you would be more productive if you could just get a good night’s sleep, but that would mean moving away from the bowling alley, and that would put you over budget and in danger of being fired.
The company doesn’t feel great about measuring your line-item expenses either. They know it’s not a great proxy for your productivity, and the truth is they actually want to pay you based on a true measure of value. Unfortunately, they just aren’t sure how valuable you are. They’ve asked you for the data, but you don’t have a system to track it—not to mention, you tend to show up to work a little worse for the wear. You always seem tired and your hair looks rather unkempt. (Don’t you know someone who will cut your hair for free? The other employees do.)
If we start to fully fund nonprofits for their day-to-day program and overhead expenses, and abandon overhead measurements as a proxy for mission fulfillment and efficiency, it’s the equivalent of giving nonprofits control over their paycheck. With the flexibility to manage their own funds they can make better spending decisions—like moving away from the bowling alley, not spending so much on business attire, and finally getting a haircut. Despite the fact that they are spending less on items that “directly support the work” (business attire, coffee) and more on “overhead” (rent, haircuts), the nonprofits can make smarter spending decisions that actually let them produce more value. Without a doubt, this arrangement would be a huge improvement over the status quo.
**Excerpt from Nonprofit Quarterly’s winter 2015 edition, “When the Show Must Go On: Nonprofits & Adversity.” It was first published online on January 25, 2016. Check out next quarter’s Overhead Bin for more from this important article