Over the last few months, I have been challenging false “facts” that are harming the nonprofit sector. I’ve been saving a big one to challenge as we kick off 2022: We must have low overhead to be considered well-run.
The Incomplete Story of Overhead Percentages
What is the “right” percentage of overhead? The question comes up in every single cohort of our Fuel Series Workshops, and it comes up in our R-Squared Peer Groups. And no one likes my answer: It depends.
You won’t hear me say that overhead costs shouldn’t be examined. Donors want to make sure their dollars are used well, and not wasted on bureaucracy or excessive spending. This is both a valid and reasonable perspective. But you will hear me say that overhead costs, when viewed merely as a line item, tell an incomplete story. And many nonprofits react to the donor’s valid question in ways that jeopardize their impact and undermine their sustainability, rather than realizing that the answer lies in telling the rest of the story.
The Complete (and Better!) Overhead Story
The rest of the story is harder to tell, but it still can be a good story. Let me be clear. Overhead costs are not waste. They are not extras. They are critical investments in the organization. And, too often, I see organizations make short-sighted decisions to hit the magical and arbitrary 20 percent overhead target by chronically under-investing in revenue generation, professional development, and operating efficiencies.
Trying to keep fundraising costs artificially low is a key driver of the revenue instability we see across the sector. The way I see it, organizations that do revenue generation on a shoestring end up forced to do everything on a shoestring. It’s just that simple. Investing in building the revenue capacity of your organization, like we do through our Fuel Series, pays off.
In addition, the way we look at overhead often misses the payoff. If an organization hires someone in 2022 to raise funds for a new program, but the program expenses won’t hit until 2023, it throws off the ratios in 2022. As a donor, I like the idea of proactive investment in revenue to build a sustainable program. It may be more work to tell it, but it’s a better story.
This line item is often the first to get cut when an organization is trying to hit a ratio or is doing some belt-tightening. In this sector, many see these costs as extras. That is a mistake. With labor shortages hitting every industry right now, and turnover and burnout rates hitting nonprofits especially hard, now is not the time to cut things that lead to better retention and less burnout. We hear leaders talk about the need for this investment in our R-Squared rooms all the time. The short-term cost of professional development is much less than the future cost of losing a critical employee.
Investments in financial and technical systems that streamline processes and improve reporting can free time and energy for program impact and help executives make better decisions. There are times when strategic investments here help propel the organization to a new level of organizational maturity. Failing to invest in those moments may preserve overhead ratios for the year, but ultimately lead to long-term inefficiencies.
Overhead costs tell a piece of the story about an organization’s efficiency and effectiveness, but the rest of the story is critical. A well-run nonprofit makes prudent investments in technology, revenue capacity, and people. That means a well-run organization should occasionally spend more on overhead, regardless of what it does to their ratios.
That is the story I tell when people ask me about overhead. It’s a longer story to tell, but it’s still a good one.