Budget Cuts and Sudden Overhead Conundrums

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I know you don’t want to hear that tough times occur in cycles; and I do recognize the alarming “perfect storm” elements of our current economic situation. But as bad as things may be right now, it’s important to remember that we’ve been through tough times before, and if we look back we may be able to glean some useful lessons that will help us in the here and now.

During a period of declining revenue in the mid-90s, as Vince Hyman and I were preparing to write Coping with Cutbacks, we surveyed and interviewed nonprofit leaders around the country to find out how they planned to cope. One of our more interesting findings was that while 50 percent of respondents expected to cut expenses, only 20 percent believed they would need to reduce services as part of this reduction.

What is the meaning of this discrepancy? Is there so much waste endemic to the sector—such overwhelmingly high administrative costs, for instance–that cuts, even when they’re in the double digits, are negligible? Of course not!

When hit with cutbacks, we could just cut services. But doing so often has real human consequences that are hard to turn away from or live with. Instead, nonprofit managers often try to make cuts skillfully to minimize the effect on clients and customers. Despite our best efforts, however, there are times when cuts in programs are impossible to avoid. Far from having a lot of slack to play with, most nonprofits, particularly small to mid-sized ones, generally run on a very thin margin of administrative infrastructure. This, unfortunately, often causes overhead costs to rise in proportion to program costs, at least temporarily, when unavoidable cutbacks in programs occur. This is the last thing we want to explain to funders in an increasingly competitive environment. If this is happening in your organization, the following discussion of why it’s happening and what to do about it may be helpful.

There are three obvious reasons why overhead may increase when your overall budget is cut:

  • If you’re a small organization and are trying to make cuts in management, you may not have a lot of opportunities or areas in which to make them. Staff salaries and benefits tend to dominate overhead costs. If you have one or two managers in an organization, and a program that constitutes nearly a quarter of your funding is eliminated and you lose another 5 percent of your budget in foundation grants, it’s kind of hard to lop off part of a manager. Additionally, good stewardship would have you spending more time, not less, on fundraising and other overhead activities until you’ve exhausted all options for keeping your programs alive.
  • A second reason has to do with where you may be in your organization’s life cycle. If, for instance, you’re in the stage where you’re spending money to build internal systems–often remedially–it’s a very bad time to make overhead cuts of any significance. Very likely you’ve gotten a sense of the risk that the lack of adequate financial and human resource and documentation systems poses for the organization and its relationship to funders and regulators. It’s pretty clear you can’t just stop short of what needs to be done.
  • The third reason is that in small organizations, some of your more critical and high-profile staff are probably in management positions. The last thing you may want to do at this point is to lose stars or relinquish the relationships that key staff have crafted and kept in play.

Over time, of course, most organizations will figure out strategies to rebalance overhead with total budget.

You may be able to achieve some gains during this difficult period. If you’ve been considering changes to your organization’s structure, this may be the time to make them. For example, if you’ve had to reduce the number or size of your programs, you can often restructure your staff to reflect the need for less management. Sometimes this shift can actually enhance programs. Perhaps a manager can now spend more time in direct programming, or one manager can replace two by supervising more programs, thereby improving cooperation and coordination as well as cutting costs. Be sure to involve every program manager in fundraising—and to correctly attribute the part of fundraising that is program planning to your program budgets rather than central administration.

Some organizations will look to partnering strategies. If program cuts result in reduced workloads for your bookkeeper or receptionist, consider sharing the position with another organization. I have also seen organizations effectively share program staff, such as intake workers or job development specialists. Similarly, unused space in a building may be rented out to similar or complementing organizations to supplement your budget.

Alternatively, managers can look at outsourcing previously in-house functions if doing so will provide a significant cost savings. Again using the example of financial staff, you may wish to investigate back-office service providers, though the transition will entail some costs, even if only in terms of managers’ time and attention.

As you consider cutting overhead, keep the following cautionary concepts in mind:

Accountability: Analyze your organization’s ability to measure and report what difference you’ve made in the world. As you make cuts in your current overhead, you don’t want to damage your ability to report to funders in the future. If you slow down or eliminate the development or maintenance of financial reporting or evaluation systems, you could hamper your ability to compete for funds. Stakeholders outside the sector will still expect you to be accountable.

Restricted Funds: While you might want to cut expenses in management systems, you need to make certain that your grants or contracts don’t require you to spend funds to strengthen fundraising, reporting/evaluation or system development. You’ll need to meet your obligations to the funders unless you can get their prior approval to redirect the money for direct service.
Good Management Principles: When reducing overhead consider the basic principles of good management before you make cuts:

  • Make certain there are regular and consistent methods of communication among staff, volunteers and supervisors—cleaning up communication messes can be costly.
  • Don’t cut corners on checks and balances—they’ve been built in for a reason. 
  • Don’t expect managers to supervise too many staff—having more than 10 direct reports to a single supervisor can cause problems. 
  • Don’t cut costs by violating what you say you’ll do in contracts and agreements with funders, in your bylaws, board policies or management policies.

Internal and External Messages: Whenever you make cuts in overhead such as training, travel, evaluation, fundraising, and newsletters, you’re sending a message to staff, clients, the public, and funders. You want to be sure these cuts are not viewed as a statement of major financial problems or a misstatement of what is important to the organization. Internally this can cause you to lose your best staff, and externally you may lose donors or funders.

But the truth is many smaller organizations will find they don’t have a lot of wiggle room, and what they do have usually needs serious study and consideration in terms of potential cost savings versus weakened capacity. This means you need some leeway.

You may need to talk with your funders to get the time you need to make the right decisions. Here are some suggested topics and approaches:

  • Funders who remain with you after an entrenchment need to understand the totality of conditions placed on the organization’s funding. You may have already had advisors blithely advise you to “analyze all your activities and eliminate the least important and effective”–thus assuming a whole lot more flexibility than is likely to exist. It may well be, in fact, that your most mission-critical programs have been de-funded and that marginal activities endure. It is probably worthwhile to let your most sympathetic funders know about any problems with the new mix so they can help you adjust.
  • If you’re building new systems and have folded their development into your overhead, negotiate to have some portion of those costs considered as one-time expenses.
  • Finally, remind your funders that in solving any current imbalance you must take into account the future viability of the organization if their investment is to be guarded. Urge them to be patient and to invest strategically in your capacity to make decisions that will help and not ultimately undermine your ability to serve your mission. If you do find yourself needing special funding for a transition stage, the best sources are past funders who have a deeper investment in the organization as well as knowledge of its development trajectory, traditions and values.

Emil Angelica is a senior consultant with Amherst H. Wilder Foundation Services to Organizations. He is co-author with Vince Hyman of Coping with Cutbacks: The Nonprofit Guide to Success When Times are Tight (Amherst H. Wilder Foundation, 1997).