This article will never provide a clear definition of overhead. Unfortunately, we can’t. While overhead is most commonly thought of as the expenses presented as management and general and fundraising functions on Form 990s or audited financial statements, the accounting guidance to determine which expenses belong to which function is so vague that reasonable people make wildly different determinations about how to allocate expenses across functions. What ends up classified as overhead is so open to interpretation, even manipulation, that we cannot provide a useful or consistent definition.
McGroarty Arts Center, where I was executive director from 2005 to 2013, provides an excellent example of just how difficult it is to determine which costs are overhead and which are program. Ceramics students at the small Los Angeles center wanted to raise money for new studio equipment. They created the Annual Ceramics Exhibition and Benefit—a volunteer-driven fundraiser that exhibits curated work of emerging ceramic artists. Is the event a fundraising expense? In some years, the Annual Ceramics Exhibition and Benefit barely breaks even—but the event is so highly mission-aligned and impactful that the center was committed to the event whether or not it made money. So is it a program expense? As the event grew in popularity and artistic reputation, the staff devised ways to capitalize on its momentum. Guided gallery tours are arranged for local schools and senior centers, and private receptions are held in the evening for the organization’s most important donors. Fundraising expense?
The accounting guidance does not tell us how to allocate the Annual Ceramics Exhibition and Benefit expenses across functions. The art center struggled to present the event expenses accurately, treating it as a fundraising expense in some years, a program expense in others. Some years, the art center came up with complicated rationales for allocating a portion of expenses across functions. Each year, the center consulted with tax accountants and auditors. Each year, it was told that its allocation was reasonable. The center would have been better served to allocate the entire event to programs and use its limited staff time on something beneficial to the organization. But the center’s leaders desperately wanted to be truthful and abide by the rules.
Nonprofits spend far too many resources attempting to report their functional expenses honestly. Costly time studies and complicated time sheets are used to determine how many hours each staff member spends on programs. Organizations build and maintain complicated accounting structures so every expense can be reported by function. A simple phone bill is recorded in the books as a lengthy journal entry of functional allocations, with back-up detail for the auditor to test at the end of the year. To what end?
The reporting of functional expenses exacerbates the myth that, somehow, nonprofits should be able to operate programs without an administrative structure to manage, measure, and execute. It implies that, by some as-yet-unknown magic, nonprofits should be able to achieve their mission without dedicated and systematic fundraising efforts to pay for it. The attempt to segregate interwoven and complementary expenses according to the function they serve is an exercise in futility. The truth is, all resources spent by a nonprofit are spent in order to successfully deliver on programs (with obvious exceptions made in cases of fraud). Certainly, not all spending in a nonprofit is efficient; but functional expenses tell us nothing about efficiency.
By abandoning overhead, we free up limited nonprofit capacity to focus on more important measures. With the coming sector-wide shift toward outcomes-based measurement, this capacity is needed now more than ever.