Striking the right overhead-spending balance is always a delicate dance for nonprofits.
Charitable organizations have long been pressured to keep overhead expenses light— the rationale being that low overhead equates to, “low waste,” and makes a charity more appealing to funders looking to make the most impact with their charitable dollars.
On the other hand—nonprofit leaders need to spend money on overhead in order to grow their organizations, reach new donors, recruit and train staff, and ultimately grow their impact.
There’s also a growing body of evidence suggesting that organizations that invest more of their budget on overhead may actually be more likely to achieve their mission compared to those that skimp. Let’s take a look:
What are overhead costs?
Overhead costs are expenses that are essential to an organization’s operation, but not directly connected to program expenses (which are directly incurred when an organization carries out a program or activity to fulfill its mission).
Overhead can include monthly operating expenses, like the cost of renting office space or paying internet bills, as well as administrative costs like insurance and accounting fees. Some overhead, like rent, may be fixed costs, while other costs like advertising, human resources (HR) costs, and legal fees may fluctuate from month-to-month.
The traditional argument (backed by nonprofit financial experts and donors alike) is that funds being spent on operating costs are funds not being spent on charitable programming. Organizations that spend more on overhead are seen as wasteful and poorly managed, while those that keep overhead spending slim are viewed as nimble and more efficient in carrying out their missions.
Charity watchdogs (which heavily influence where funders choose to give) almost always consider overhead ratio—or how much of an organization’s budget is used for overhead costs vs. charitable programming—as a metric for assessing and rating an organization’s efficiency. CharityWatch, for example, reserves its “highly efficient” rating for organizations that spend less than 25% of their budget on overhead and save at least 75% of funds for direct programming costs.
What is a good overhead ratio for nonprofits?
At what point does spending more on overhead stop enhancing an organization’s operations?
That’s the question public administration scholars Hala Altamimi and Qiaozhen Liu set out to answer in a September 2022 report published in the academic journal Nonprofit and Voluntary Sector Quarterly.
For 11 years, the scholars collected data from 22,328 arts and cultural nonprofits in the United States (US) (mainly museums and theatres) and analyzed two factors: how much of their budget was used to cover overhead, and how successful their events and exhibitions were. If event attendance increased over the 11 years of data collection, the organization was deemed successful and efficient in achieving its mission.
Here’s what the study found:
- The organizations that spent the least of their budget on overhead saw their attendance decline by 9%
- The organizations that spent the highest amounts on overhead saw attendance fall by 30%
- The organizations that were the most successful and had the highest number of visitors devoted just over one-third, or 35% of their budget, to overhead spending.
The authors make clear that just because 35% was the sweet spot for overhead spending for arts and culture nonprofits, doesn’t mean it’s the right ratio for all organizations. Rather, the finding that spending a healthy amount on overhead helps organizations succeed in the long-run opens up a conversation about unrealistic expectations—and suggests a need for more nuanced assessments when judging the impact of charities and determining the “right” amount to invest in overhead.
The study specifically calls out a phenomenon called “the starvation cycle,” which occurs when nonprofits feel pressured to keep overhead costs down, and in-turn sacrifice infrastructure, general improvements, and investments that promote employee wellbeing.
To cut down on overhead, organizations may fail to update equipment and technology, pay non-competitive salaries, skimp on employee benefits, and even replace paid staff members with volunteers—in turn sabotaging their efficiency and longevity.
Strategies for smart overhead spending
Financial decision-makers should feel empowered to spend on overhead in order to improve operations, take care of staff, and build a sturdy organizational infrastructure. However, in order to invest in purposeful overhead that helps strengthen and build up their organization (like generous employee benefits packages, employee training, and information technology (IT) upgrades), nonprofit leaders need to assess their budgets and trim costs where they can. One obvious way to save money is by becoming a reimbursing employer.
Nearly 86% of 501(c)(3) nonprofits are overpaying on their state unemployment insurance taxes (SUI) meaning that every month, they pay more in taxes and unemployment insurance (UI) benefits than they ever cost the state in unemployment claims. Put another way, this means that 86% of charitable organizations are unwittingly funding the UI benefits of other organizations in their state, including for-profit businesses and corporations.
501(c)(3)s do not have to pay state unemployment insurance taxes and can save as much as 40% on their unemployment costs by opting out of the unemployment insurance tax system.
When nonprofit organizations become reimbursing employers, they skip paying into a government pool of UI taxes, avoid UI tax increases, and pay only for their own unemployment charges, allowing more financial control and a clearer picture of their yearly budget.
The 501(c) Agencies Trust can help you safely opt out of your state’s UI program and build a reserve account that you own, and that earns interest through sound conservative investing. 501(c) Agencies Trust monitors and handles all your unemployment claims and reimburses the state for any paid claims. Our program has almost 1,500 participants and saves them an estimated $20 million in UI taxes annually.
To see if your organization would financially benefit from our services, please complete a Request for Information Form today.
Lia Tabackman is a freelance journalist, copywriter, and social media strategist based in Richmond, Virginia. Her writing has appeared in the Washington Post, CBS 6 News, the Los Angeles Times, and Arlington Magazine, among others. She writes nonprofit-specific content for 501c.com.
