The Truthiness About Overhead

The Truthiness About Overhead

While overhead or administrative spending has become a way for many funders to measure how well a grantee is doing, a growing number of funders and nonprofits are finding that it doesn’t paint an accurate picture of a nonprofit’s financial health, sustainability and overall effectiveness. In particular, recent dialogue in the field is raising questions about how we assess a grantee’s potential for success and the effectiveness of its operations. What information helps us best understand the impact of a grantee or potential grantee? How can we ensure our grant dollars go to the most effective grantees?

As customer service agents, policy enforcers and budget reviewers, grants managers play an influential role, shaping how this issue plays out day-to-day in grantmaking organizations. In particular, grants managers can play a role in setting their organizations on the right path when assessing grantee performance. As outlined in recent initiatives like the Overhead Myth or Real Talk About Real Costs, effectiveness is a composite of financial health, leadership strength, organizational capacity and programmatic outcomes.

Although grants managers roles can vary, Jane Ward, grants manager at the Meyer Foundation, says, “Whatever your role in the foundation, it’s always important to raise the question of whether a grantee is being funded at the level it needs to be successful.  At Meyer, we think our grants practices play a role in the success of our programs — grants management is more than just managing the processes of getting applications in and payments out.”

Despite the dialogue, confusion reigns.  Language and jargon complicate matters.  For example, some people use overhead, indirect and administrative costs interchangeably; others prescribe specific definitions. Regardless, we are referring to the expenses that are necessary to operate quality programs and sustain agile well-run organizations.  This includes things like rent, IT, financial audits, fundraising, administrative salaries, and staff training and development. Overhead is the critical base that underpins an organization’s activities and supports the organization’s ability to thrive. Too often, grantmakers take these costs for granted, when we could instead make them an explicit part of our dialogue with grantees.

It’s time to help clear the air. Below is a brief true/false quiz designed to help grants managers get to a true understanding about overhead.

True or False: The overhead rate is a measure of nonprofit effectiveness.

False.  The overhead rate is an accounting ratio that highlights the administrative costs and operating costs of an organization.  As a standalone metric, how much an organization spends on operations does not provide insight about the context of a nonprofit’s work, and most importantly, it does not measure if and how well an organization is achieving its mission — because it uses inputs (operations) as a direct measure of outputs (program effectiveness).

For the Meyer Foundation, overhead costs aren’t used as a measure of nonprofit effectiveness, but rather as a way to help ensure its grantees are able to be sustainable in the long term. According to Ward: “We have a philosophy to adequately fund management and administration, because we believe that well-managed organizations can lead more successful programs.  So if we see that a project budget has only a 5 percent line for overhead, we’re not super impressed.”

The rise of the overhead ratio is understandable. Who wouldn’t want a simple way to compare organizations to determine which are worthy of philanthropic dollars?  But the fact of the matter is that social change is complex and what’s considered to be a reasonable expense is subjective.  You wouldn’t expect your dry cleaner, tax accountant and cable company to have the same operating costs; why would we expect all grantees to be assessed by the same arbitrary financial ratio?

Understanding a potential grantee’s cost structure — including its size, programmatic focus, geography and other factors — is an important part of the due diligence processes, especially when it sheds light on where there might be gaps in capacity which funders can address.  However as noted in seminal articles like the “Nonprofit Starvation Cycle,” the overhead ratio as a standalone metric has done more harm than good.  It focuses attention on a measure that says very little about the organization’s work and results and leads to the hollowing out of its core as nonprofits are forced to continually underfund and underinvest in their operations, staff, leadership and administration needs.

True or False:  Most foundations have an overhead policy.

False.  According to GEO’s most recent national survey of staffed grantmaking foundations, only one-quarter of respondents indicated that they have a written policy regarding support for indirect costs.  This means that most grantmakers may have discretion when it comes to covering the true costs of a project.  In fact, almost two-thirds of survey respondents reported that they make decisions about allowable overhead costs on a case-by-case basis.

Even if you don’t have a written policy, there should be internal clarity on your foundation’s point of view and terminology.  In the absence of clear policy, implicit guidelines and organizational tradition may take root, sometimes in unproductive ways.   “We’ve always done it this way” becomes the standard response not out of bad intentions but out of habit and everyone misses out on the opportunity for meaningful conversation about what it costs to achieve results.

When it comes to policies or practices regarding overhead or indirect costs, flexibility is a best practice.  Flexibility encourages open dialogue between grantee and grantmaker about what it takes to achieve the desired results.  Flexibility means that the grantmaker can be responsive to the unique contexts faced by a grantee and the capacity they need to be successful.

indirect costs

True or False:  If nonprofits need more funds to cover overhead expenses, they will ask for them.

False.  In a recent survey of more than 5,000 nonprofit organizations conducted by the Nonprofit Finance Fund, only one-third of respondents reported that they can have an open conversation with their funders about their need for general operating support. (Comparatively, more than 50 percent reported that they can have an open dialogue with their funders about program expansion.)

By contrast, in GEO’s survey we found that 70 percent of grantmakers are willing to engage in open dialogue with nonprofits about general operating support.  And, nearly all respondents said it was important to provide support that will strengthen grantee organizations so they can achieve greater impact.

“When our program officers talk about budgets with potential grantees, we encourage them to make sure they’ve considered the full costs of programs,” Ward said. “But it’s so important that nonprofits themselves push the envelope when they think they can and raise the question with funders: ‘do you fund indirect costs?’ It’s very useful for funders to hear this feedback from applicants.”

Funders need to be cognizant of the power dynamics embedded in the grantee-grantor relationship that can make it difficult for grantees to initiate conversations that may cause funders to second-guess or lose confidence in them.  However, there may be other factors at play.  Our intent to nurture open and trusting relationships is not always reinforced by our behavior.  Rigid budget forms and onerous reporting convey lack of trust, as do arbitrary overhead guidelines.  After all, the most common argument for strict overhead policies is that nonprofits can’t be trusted to control costs or spend funds appropriately.

If we want grantees to have the courage to approach us with sensitive issues, then we have to create the environment for trust and openness to flourish.

Hopefully by now, it’s clear that overhead policies need to be revisited.  Grants managers can lead the way. Here’s how:

  • Be an advocate for results vs an enforcer of costs.  Grants managers often have the best understanding of nonprofit budgets.  Part of our responsibility is to understand how nonprofits operate and what their budgets represent.  Initiate a conversation with grantees about their operating costs to build common understanding about what it takes to get results.
  • Make the implicit explicit.  If there’s no formal policy within your organization, host a conversation among colleagues to get different perspectives on the table, see where there’s alignment and make assumptions explicit.  Even if you don’t have a written policy, take the lead in communicating the foundation’s point of view to grantees and take the guess work out of the process.
  • Align processes with values.  If building trusting relationships with grantees is a priority, look at processes from the grantees view to consider where you may be inadvertently conveying mistrust.

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