What is Overhead, Anyway?

Recently, I was chatting with a climate researcher who had just won a major five-year exploratory grant. He was excited… until he found out that one of his partner institutions was spending 53 percent of its grant dollars on overhead.

Paired with an anecdote about slow-moving administrative processing, the researcher was quick to dismiss the value of overhead. I thought to myself, “Katherine Lorenz would never stand for this!” But as I attempted to formulate a rebuttal I had a painful realization: I wasn’t even entirely sure what overhead is.  

Overhead is one of the first concepts any philanthropist learns. It includes all of those administrative and fundraising costs that we secretly wish our nonprofit colleagues didn’t have to worry about. But what exactly is overhead, anyway?

It turns out that the answer isn’t always simple. In nonprofits, overhead is an accounting distinction, which typically includes the general operating, management, and development costs in an organization. Sometimes folks in the philanthropic sector call overhead “support services” noting that the expenses in that category help an organization to carry out programming.

Some of the expenses that can contribute to overhead costs are salaries and benefits, office expenses, IT expenses, staff training, fundraising, insurance, postage, rent, and travel. For example, the postage used to mail payroll documents is definitely an overhead expense. However, simply because an expense falls under one of these categories does not necessarily mean it counts as overhead. Commonly, an employee’s salary is often broken down into several expense categories based on the percentage of time spent on various responsibilities.

The lines of what counts as which expense are often blurred, as there is no universal standardization of accounting taxonomy. There are egregious lies, of course, (no, your donor database cannot be expensed to your direct program categories) but the delineations become fuzzier from there. For example, some organizations employ usage percentages to determine how to categorize a particular expense. Basically, if both the program team and the development team use the same contact management software, the cost of that software would be split 50/50 (or 35/65, etc.) between their budgets. However, other organizations might be less granular in their accounting approaches. They might consider their travel budget, which is utilized by both their development and program staff to attend industry conferences and networking events, as a single general operating expense.

Depending on the taxonomy of the internal budgeting process, the expenses that constitute overhead vary from organization to organization. This means that arguments for or against a high overhead ratio are always little bit misguided. An article published by the Stanford Social Innovation Review confirms this:

The Bridgespan Group recently examined the financial records of 20 well-known, high-performing nonprofits to determine their actual indirect costs—those not attributed to a specific program or service… The median indirect cost rate for all 20 nonprofits was 40 percent, nearly three times the 15 percent overhead rate that most foundations provide. To be clear: Higher or lower is neither better nor worse. These figures are not measures of either effectiveness or efficiency. Rather, they reflect the mix of direct and indirect costs required to deliver impact.

The article goes on to suggest a paradigm shift: rather than considering the cost to complete a project, a funder should consider the cost of achieving impact. Makes sense, right? Whether an organization reports their overhead as 10% or 53% of overall expenses, it’s important for funders to consider these questions:

1. What kinds of resources, technology, and human services does it take to perform the service that you want to fund?
2. What constitutes a healthy, happy, and productive work environment for you? What kinds of benefits are attractive to you in your own career?
3. What is the “cost of living” in the communities that your grantees operate in?
4. How can you ensure that the nonprofits you support will be able to attract and retain the talented and committed staff leadership required to attain their mission?

The answers to these questions have, at the same time, nothing and everything to do with overhead. We all want our grant dollars to have a meaningful impact for our ultimate beneficiaries. It may be sexy to say that your grant dollars built 16 toilets in Africa (or whatever) but it should be equally sexy to say that all your grant dollars empowered organizational efficiency and fair wages!   

Over and over again we see the false equivocation of low overhead costs and high nonprofit performance. Katherine and countless others make the case for higher overhead. This is not necessarily one of those pleas. Rather, it’s an invitation to step back and consider the assumptions and premises of any argument involving overhead. It’s an invitation to delve deeper into our values and preferences when making funding decisions.