OVERHEAD RATIOS – PART I - DRIVEN TO A PREMATURE GRAVE BECAUSE OF INCESSANT, UNCEASING AND RELENTLESS ATTENTION TO NONPROFIT OVERHEAD RATIOS
OVERHEAD RATIOS – PART I - DRIVEN TO A PREMATURE GRAVE BECAUSE OF INCESSANT, UNCEASING AND RELENTLESS ATTENTION TO NONPROFIT OVERHEAD RATIOS
Andrea McManus, ViTreo Group Inc
November 26th 2019
“The Nonprofit Starvation Cycle
Funders must take the lead in breaking a vicious cycle that is leaving nonprofits so hungry for decent infrastructure that they can barely function as organizations—let alone serve their beneficiaries.”
As we close in on the end of 2019 (and the season of giving), and the beginning of a new decade, the charitable sector, as always, faces many obstacles. One of the most challenging issues, and one that doesn’t seem to have altered much over the years, is the conversation about the nonprofit overhead ratio. The problem is that the conversation is still ongoing.
Mark Blumberg works almost exclusively advising nonprofits and registered charities on their work in Canada and abroad. He has written numerous articles, is a frequent speaker on legal issues involving charity and not-for-profit law.
It was almost 10 years ago when Mark Blumberg, a partner at the Toronto (Ontario) law firm of Blumberg Segal LLP and a guest on a recent episode of the ViTreo BrainTrust Philanthropy podcast, The Impact of the Community Foundation, had much to say about the issue in a Global Philanthropy blog post titled How Much Should A Canadian Charity Spend on Overhead? (he wrote the blog after the elimination of the 80/20 expenditure requirement in the 2010 Canadian Federal Budget).
10 years later, Mark’s blog is still relevant and the narrative sadly unchanged.
Some highlights below (the full post is well worth reading) —
“What are appropriate overhead costs for a Canadian registered charity?
…With the elimination of the 80/20 expenditure requirement in the 2010 Federal budget many Canadians are asking how to evaluate charities and which ones are deserving of support. One of the indicators that is suggested is ‘overhead.’ But is this a good indicator of the efficiency and effectiveness of a charity?
…In the United States some services have ranked charities based on the percentage spent on ‘charitable activities’ or the ‘mission.’ One reason that these ratios are popular is that it is a calculation that involves total expenditures and total amount spent on charitable work. Seemingly this is an easy calculation to make. It certainly is easier to work out than whether a charity is ‘effective.’ While overhead ratios are interesting, these ratios usually hide a lot more than they reveal.
The biggest problem with relying on overhead is that the numbers are very unreliable….It is fair to say that two charities could be treating the same expense very differently. About two-thirds of registered charities identify themselves as having no fundraising costs, and about one-third as having no management and administration expenditures. According to the T3010 data, most charities do not spend a dime on professional services, which includes accounting and legal work.
The problem with relying on such a simple indicator is that you can easily be very wrong and the results can be pretty awful. Unfortunately, large charity scams often have great ‘ratios,’ either because they count non-charitable expenditures as charitable or because they inflate the fair market value of the work that they do, or both. A group that claims to be very efficient, spending 95% on charitable activities, and is being lauded by the media, may in fact only be spending less than 1% on charitable activities. This is a technique used by some charity gifting tax shelter schemes to make their numbers look good. Many tens of thousands of people, including individuals with very strong financial and business backgrounds, have been duped.”
Photo Credit: PWC, Investing For Effective Impact: Changing Donor Perceptions About Not-For-Profit Efficiency In Canada, January 2016
Yet, in the past 10 years, the conversation about nonprofits and overhead has continued to be still very much alive. I thought this GuideStar 2018 article Why Is Overhead Expected in the For-Profit Sector, but a Punishable Offence for Nonprofits? did a stellar job of asking the right questions.
How the Perception of Overhead is Hurting the Causes We Love
Somewhere along the way, our society decided to think differently about overhead in the nonprofit and for-profit sectors. This decision did not consider the consequences and how it can negatively affect the organizations that could change the world. Why is it that we consider helping people to be worth less compensation, and that a career that helps no one should be worth over double the salary? How can nonprofits scale, and therefore expand their causes, when they are expected to forego investment? Wouldn’t we prefer that a cure for cancer be found, or every person on Earth have clean water, no matter how much the organization spends on administration?
Charitable sector watchdog agencies such as Canada’s Charity Intelligence conduct annual reviews of charities. In Charity Intelligence’s case, it reviews more than 750 charities nationwide on results, transparency and accountability, as well as “in-depth primers on philanthropic sectors like Canada’s environment, cancer and homelessness.” It then awards them a rating between 0 and 4 stars. According to its website, well over 300,000 Canadians use the website to help them make their donation decisions. An explanation of its metrics and how its ratings are decided upon for both donors and nonprofits is available here.
This always raises the question — Are the metrics being used the right ones? And how accurate is the information they are using to rate each charity? And…how many donations may be lost or given to another organization if the information is inaccurate. It also goes back to the Guidestar article quoted above — What difference do some of these measurements make if we achieve something as momentous as curing cancer or another terminal illness? You’ve cured cancer. How do you put a price on that? Do you say, sorry we’re almost there, but our rent went up this year and so the rest of the research needs to wait until the new year?
As both Blumberg and Tatham ask — Would you rather be efficient (low overhead ratio) or would you rather be effective (achieving impact)? As a nonprofit or fundraising organization, if you have achieved your mission of doing good in this world — saving lives, providing better healthcare or education, reducing domestic violence or one of the other myriad of social causes that need and deserve support — does it really matter if you (the nonprofit or charitable organization) spent 20% or 99% on administration costs and overhead expenses, if you achieved your goals? Apparently it does. Or I wouldn’t be writing this blog and the conversation would be over.
And why, as Katie Tatham asks, is the goal of creating profit (financial returns) more worthy of attention and funding than the goal of helping humanity and creating a better world (social returns)? That’s a pretty sad statement on what appears to be considered valuable by many…
I have often said nonprofits should take their lead from for-profit organizations when it comes to strategy; many of them would be more successful at achieving their mission if they operated within a business model. If we continue to look to the for-profit world in order to be more effective, risk capital and investing in new technologies, etc., is de riguer because it leads to more effective tools, techniques, and methods of operating.
But in our world, the charitable world, this type of investment would be considered by many external audiences as administration and overhead. Funders, donors, government and other stakeholders often do not see the correlation between investment and a more effective way of achieving the mission, which IMHO, is a shortsighted view.
This scarcity approach extends to investment in human capital (a major part of delivering on mission), competitiveness (for philanthropic dollars, grant dollars) and just about everything!
From an article on the Stanford Social Innovation Review and in their report The Nonprofit Starvation Cycle, the authors stated:
“Organizations that build robust infrastructure - which includes sturdy information technology systems, financial systems, skills training, fundraising processes, and other essential overhead- are more likely to succeed than those that do not. This is not news, and nonprofits are no exception to the rule.”
Also in the Stanford Social Innovation Review report, the authors talk about the research findings by the Nonprofit Overhead Cost Study, a five year research project conducted by the Urban Institute’s Center on Nonprofits and Philanthropy and the Lilly Family School of Philanthropy at Indiana University and the heart of the problem — funders’ unrealistic expectations. And in turn, our (nonprofits and charitable organizations) contribution to the issue — in order to appease donors and funds, we in the nonprofit world try to reduce overhead, making it difficult to help the beneficiaries of our work….
Photo Credit: Stanford Social Innovation Review, Nonprofit Starvation Cycle, Ann Goggins Gregory & Don Howard, Fall 2009
“Underfed Overhead
In response to pressure from funders, nonprofits settle into a ‘low pay, make do, and do without’ culture, as the Nonprofit Overhead Cost Study calls it [….] reveals that a vicious cycle fuels the persistent underfunding of overhead. The first step in the cycle is funders’ unrealistic expectations about how much it costs to run a nonprofit. At the second step, nonprofits feel pressure to conform to funders’ unrealistic expectations. At the third step, nonprofits respond to this pressure in two ways: They spend too little on overhead, and they underreport their expenditures on tax forms and in fundraising materials. This underspending and underreporting in turn perpetuates funders’ unrealistic expectations. Over time, funders expect grantees to do more and more with less and less—a cycle that slowly starves nonprofits.”
Caroline Riseboro, CEO of Plan International Canada and President, Board of Directors of the Association of Fundraising Greater Toronto chapter, also sums up the issue well in her research paper, Rating Charity Overhead Rates: The Limitation of Overhead to Determine Charity Performance:
Underinvestment in Critical Infrastructure
In an effort to keep overhead ratios low and attract the interest of donors, studies have suggested that charities often underinvest in the critical infrastructure they require to be as effective as possible. Such infrastructure investments include technology systems, staff training and development, process efficiency and other essential operations. While a low overhead rate may satisfy public demand and serve as a substitutionary measure for efficacy, the evidence indicates that it perpetuates a persistent underinvestment in infrastructure which destabilizes the ability of charities to best achieve their intended mission.
And more recently in 2018, from the NC State University Philanthropy Journal:
“In a recent study coming out of NC State, researchers Jason Coupet and Jessica Berrett challenge the status quo of using financial ratios for measuring the efficiency of nonprofits. The researchers argue that relying on measures like the overhead ratio is an inappropriate evaluation of efficiency because it does not consider outputs. Instead, they suggest alternative models, pushing for a more instrumental approach that can take into account the actual services that nonprofits provide.”
So, we’ve talked in-depth here about the very BIG problem. Now, what do we do about it?
In his 2013 TED Talk The Way We Think About Charity Is Dead Wrong, “Activist and fundraiser Dan Pallotta calls out the double standard that drives our broken relationship to charities. Too many nonprofits, he says, are rewarded for how little they spend -- not for what they get done. Instead of equating frugality with morality, he asks us to start rewarding charities for their big goals and big accomplishments (even if that comes with big expenses). In this bold talk, he says: Let's change the way we think about changing the world.”
- TED Talks, The Way We Think About Charity Is Dead Wrong, Dan Pallotta, March 2013
I agree. It saddens me to no end that many of these references are 8, 9 , 10 years old and they are still relevant.
Photo Credit: Boston Globe
The conversation needs to change. And how do we accomplish that? Well, as always, it’s good to start at the root of a problem. In this case, the unrealistic expectations of funders and donors — although a few, but not enough, foundations have begun to eliminate or severely limit the review of ratios from their calculations. Board members and even CFOs also contribute to the problem. And then from there, we must change our own behaviour, as we (the charitable sector) are also complicit.
Tune in again on December 3 and December 10 as The Provocateur talks about solutions before we move on to the holiday season, reflections on the past year and thoughts about the coming one.
There are many other excellent sources of research and thought on the issue of overhead ratio including:
ROI and Net Revenue are a Contradiction in Terms…Making The Case For Net Revenue by Tom Hurley
Friendship, Courtship, Partnership, Why Canadian Nonprofits Need to Think About Working Together Differently by Patricia Evans and Barbara Grantham
Check out ViTreo's Braintrust as we bring you additional insights into what is and what will be important in philanthropy through our Weekly News Recap and our BrainTrust Philanthropy Podcast.
ABOUT THE AUTHOR
Andrea McManus, Chair, Board of Directors, Partner
ViTreo Group Inc
Andrea McManus is a Partner with ViTreo with over 30 years’ experience in fund development, marketing, sponsorship and nonprofit management. A highly strategic thinker and change maker, Andrea has worked with organizations that span the nonprofit sector with particular focus on building long-term and sustainable capacity.