The Means of Measure

by Erin Jones, May 27, 2011

Is the overhead to program ratio a more important measure of an organization's effectiveness than its accomplishments and outcomes?  A study referenced in The Nonprofit Starvation Cycle (an excellent article produced by the Stanford Innovation Review) found that individual donors consider this ratio a more important factor in determining whether to give to a charity than the success of the organization's programs.  But if you attended Kay Sohl's workshop on "Funding Indirect and Overhead Costs" at the Nonprofit Association of Oregon, you could already begin to unravel the graver issues at hand.  Specifically, what are we even talking about when we say "overhead", and what substance lies beneath the numbers?  If we as a sector and a community routinely fail to grasp the definition of overhead, administration, indirect, and shared costs, how can the public make investment decisions based on these terms?

Two situations:

Nonprofit A, riddled with the many issues brought on by underfunding administrative and indirect costs, fails to efficiently serve its beneficiaries, but reports very low (or perhaps misrepresents its costs and reports close to zero) administrative costs.  

Nonprofit B decides to invest in new computers, higher-level administrative services, and other infrastructure building expenses.  While Nonprofit B’s actions improve their sustainability and effectiveness in serving their beneficiaries, spending on these necessary capacity building expenditures raises their administrative and indirect cost ratios.  

The first scenario is dire yet common.  The second is inspiring yet rare.  Why would any funder or individual congratulate Nonprofit A and admonish Nonprofit B?

Perhaps, at first glance, it's easier to evaluate a percentage than to understand that the very percentage evaluated, without a narrative, tells no story, and provides little information about the works and benefits of a nonprofit.  As accountants, we believe that an organization's financial statements communicate information about financial health and activities.  Internally, they can help Executives, Program Managers, and Boards make decisions about direction, growth, and other key issues that affect their beneficiaries.  But as long as donors, the media, and other stakeholders continue to weigh an arbitrary percentage higher than outcomes, the nonprofit sector and the people they serve are bound to suffer.

Reading List:

"The first step in the cycle is funders’ unrealistic expectations about how much it costs to run a nonprofit.  At the second step, nonprofits feel pressure to conform to funders’ unrealistic expectations.  At the third step, nonprofits respond to this pressure in two ways: They spend too little on overhead, and they under report their expenditures on tax forms and in fundraising materials."  -  The Nonprofit Starvation Cycle, Stanford Social Innovation Review

"There’s a growing agreement between high-powered academics, the U.S. Government Accountability Office (GAO), and down-to-earth nonprofit leaders that underinvestment in infrastructure poses a serious threat to the effectiveness of nonprofit organizations." - Starving Infrastructure Damages Effectiveness & Sustainability, Kay Sohl

"Nonprofits fund indirect costs with a variety of...funding sources, and when indirect cost reimbursement is less than the amount of indirect costs nonprofits determine they have incurred, most take steps to bridge the gap. They may reduce the population served or the scope of services offered, and may forgo or delay physical infrastructure and technology improvements and staffing needs. Because many nonprofits view cuts in clients served or services offered as unpalatable, they reported that they often compromise vital 'back-office' functions, which over time can affect their ability to meet their missions." - Government Accountability Office