Perhaps donors have inquired about your organization’s “overhead ratio.” Or, you’ve been asked by a prominent donor to confirm why your “overhead is so high.” What’s with the emphasis on overhead? Is it healthy? What, if anything, can nonprofits do to change the misconceptions people have about overhead?
The Myths About Overhead and Overhead Ratios
GuideStar, Charity Navigator, and other sites use some form of overhead or the overhead ratio to assess a nonprofit’s efficiency. But is this a fair number to use?
Since the aftermath of Hurricane Katrina, when journalists investigated the Red Cross’ finances in light of its handling of the humanitarian relief efforts, the term “overhead” has served as a red warning light instead of a natural descriptor of a particular type of expense a nonprofit naturally uses.
Many see overhead and the overhead ratio as synonymous with efficiencies. A nonprofit with low overhead costs, for example, may be viewed as thrifty, efficient, and better able to serve its constituents.
In truth, overhead may have little or nothing to do with efficiency. A nonprofit located in a large city may have greater overhead expenses due to higher rents, higher salaries needed to stay competitive in the local job market, higher utilities, and much more. A city-based nonprofit may need to remain in its present location to serve its constituents, so moving to a location with lower overhead costs is out of the question. In this small example, such a nonprofit may show higher overhead costs than its rural counterpart, but it may be just as effective, if not more so, at fulfilling its mission than a similar organization with lower overhead.
What Can Nonprofits Do to Combat the Misconceptions of Overhead?
Researchers H. Qu and J. Levine Daniel conducted a study examining the use of the term “overhead” among nonprofits. What they discovered was fascinating. If nonprofits simply redact the term overhead, but use the same descriptive phrasing to truthfully and accurately identify the expenses allocated to overhead, the negative connotations expressed by the public disappear. Framing the conversation around overhead by addressing the need for such expenses is equally as important to ensuring transparency and understanding among donors.
Nonprofits can, for example, help donors understand the need for overhead expenses. Clarifying their reasons for bearing higher costs is very helpful. For example:
- When subjects in Qu & Daniel’s study were asked to define overhead, few among the general public could do so with any degree of accuracy. The word itself had become so negatively charged with meaning that it lost its original objective meaning. Therefore, providing a clearly defined meaning of overhead in financial and marketing statements, without using the specific term, may achieve the same goal of transparent communications without the negative connotation.
- High nonprofit salaries are often perceived by the public as “greed” on the part of executives. But in order to attract and retain top talent, nonprofits must offer competitive salaries to woo executives away from jobs in the for-profit sector. Donors certainly want qualified leaders at the helm of a nonprofit, and the best leaders will help the organization achieve its mission and vision more effectively. Stating this argument in a positive light can help nonprofits frame the salary and expense category as part of overhead costs.
- Explaining overhead as an investment in long-term, sustainable growth, may also alleviate donors’ discomfort with the term.
Nonprofits need unrestricted overhead in order to transact business and continue operations. With the public still feeling the negative taint of the term, however, it is wise to find alternative ways to describe the need.
Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact Welter Consulting at 206-605-3113 for more information.