Editors’ note: This article, first published in print during Nov/Dec 2003, has been republished for Nonprofit Quarterly with minor updates.

You may remember a controversial practice of the early 1990s called “outing.” As the name implies, someone would find out that a famous person was gay or lesbian and would “out” this person by telling the press. The purpose of “outing” was not primarily intended to hurt the person, but to make the statement that in order to change societal attitudes towards gays and lesbians, it is necessary that famous or well-respected public figures be open about their sexuality, thus leading to greater acceptance of all sexual orientations.

I think we now need to “out” administrative or overhead costs. Organizations have administrative costs. These are legitimate costs of doing business, and in fact, without enough money spent on administration and fundraising, the organization will not be healthy. Some organizations are able to raise a lot of money because they have figured out how to hide these costs — not because they don’t have them. Small grassroots organizations, on the other hand, sometimes appear to have high overhead costs because they tell the truth about how they spend their money, not because they waste money.

A constant obsession with many nonprofits is figuring out how to disguise the amount of their administrative overhead. Organizations often ask me questions like these: “If our fundraising appeal has an educational element, can we put some of the cost of it under program?” or, “Do we have to show rent as an overhead cost or can we divide it among all our projects?” Similarly, a donor told me recently that she gave $5,000 to an organization that had promised her that none of her money would be used for administration. She asked me if I thought they were telling the truth. I told her they probably were, and the reason they were not going to spend any of her donation on administration is that they were spending 100% of someone else’s gift on that.

Administrative costs are legitimate costs of doing business.

Ironically, some of the problems we have with being open and above-board about administrative costs come from foundations, many of which will only fund “program work.” This practice has long forced organizations seeking grant funding either to disguise overhead costs as program or to raise overhead funds elsewhere. Many times, organizations would be well funded for a project while scraping to pay rent. Ironically, many of these same foundations are now protesting Congress’s efforts to increase their payout rate, furiously defending their costs and claiming that the quality of their grants program will go down if they have to dip further into their assets or cut costs. If nothing else comes out of this controversy, I hope that foundation program officers will take a more realistic view of the cost of doing business when they recommend proposals for funding.

Another reason groups try to hide what they spend on non-program costs is that they live in fear of being mentioned negatively in the papers. The press seems to love to write about nonprofit scandals, which include real scandals and then bogus “exposés” on overhead. Headlines such as, “Charities Could Save $100 Billion,” or “Nonprofit Compensation Up,” or “A New Charity Watchdog Rises” give the impression that many nonprofits do not use money wisely.

More and more, donors are not asking what an organization does or what its mission is, but rather, “What percentage of my money goes to program?” They have been taught to be suspicious of how organizations use their money and told that the less organizations spend on non-program costs, the better they are run.

However, neither donors, nor foundations, nor organizations themselves have a firm idea of what percentage of budget is legitimate to spend on overhead. Is it the 35% recommended by the Wise Giving Alliance, or the 5% to 10% recommended in a Harvard Business Review article by Bill Bradley and the consulting firm McKinsey and Company (who previously consulted to Enron)? In fact, many charities and donors don’t even have a coherent definition of what overhead is. A donor wrote to me recently saying, “I have stopped giving to X organization because they had both overhead and administrative costs. I was willing to have one or the other, but not both.

ORGANIZATIONS WITH “LOW OVERHEAD”

We rarely read stories like the following, which indicate what happens to organizations that don’t understand the value of proper administration. These are true stories disguised to protect me from the anger of each of the executive directors.

Organization A has three very committed social workers providing direct service to a much-too-large caseload. They are widely admired for their dedication. The social workers are compassionate and work well with clients. However, they cannot be bothered to fill out forms, write reports, or “deal with all that bureaucratic stuff,” which is what they call anything related to paper. Their reporting failures have caused the organization to miss several grant opportunities, resulting in the loss of thousands of dollars. The agency administrator works long hours trying to piece together the information needed for various reports, as well as balance budgets, pay bills, and run interference with funders. The organization is now in a budget crunch (predicted months ago by the administrator), and the board recommends laying off the administrator. “Cut overhead” says the board chair. “Our services are more needed than ever.”

A constant obsession with many nonprofits is
figuring our how to disguise the amount of their
administrative overhead.

Organization B has an executive director who loves “program work.” He does not like fundraising, writing reports or supervision. He has two other staff who are largely left to their own devices to figure out their work. One has figured out that he can steal upwards of $2,000 a month in forged reimbursements, petty cash, and charging office supplies to the organization’s account, then reselling them to other people for cash. Discovering an inordinate amount of money being spent on office supplies, the board treasurer suggests “cutting overhead.” It takes an audit a year to discover the truth. (By the way, an audit is an administrative cost.)

WHAT ARE ADMINISTRATIVE COSTS?

Certainly donors have the right to demand that their money be used properly. The question is how an organization can show donors that their gifts are being well used and educate the donor public about what to look for when evaluating groups’ spending. In fact, organizations themselves need to know how to evaluate if they are spending enough or too much on overhead costs. What the donor deserves and what the organization wants is the same thing: for the group to use all their money as wisely as possible in the furtherance of their mission. To do that will require spending money on fundraising, evaluation, accounting, data entry, and so on, as well as on more direct program costs.

The rest of this article is about ways to educate ourselves and our donors about administrative costs. First, some definitions.

Is there a difference between “overhead,” “administration,” and “indirect costs”? Perhaps someone with a Ph.D. in accounting can provide a more nuanced definition, but from the point of view of a lay donor, there is no difference. These words are interchangeable. My friend who was wasting her outrage on a group that had both administrative and overhead costs was confused because they used both those words in their financial report.

IS FUNDRAISING AN ADMINISTRATIVE COST?

Generally it is, although some groups talk about “administration and fundraising” and some donors will want to know what percentage of income is spent specifically on fundraising. An organization will want to keep track of fundraising costs so it can evaluate its fundraising efforts in order to decide which ones to expand, which ones to drop, and which ones to revise. (Cost is just one factor to take into account in these decisions, but it’s an important one.)

So you want to pick a word and stick with it. In her excellent article, “100% Goes to Charity?” in the January February 2003 issue of Foundation News and Commentary, Lee Draper writes, “Indirect costs, overhead, and administrative expenses do not convey the correlation of the expenditures to the quality and quantity of programming.” She suggests instead using words or phrases such as, “infrastructure expenses,” “core agency support,” or “organizational investment.” Choosing a new word or phrase to denote these costs may be helpful in changing your paradigm and that of your donors.

I like administration or administrative expense because of the Latin roots of those words: ad (to or toward) ministorage (serve). Administration is a service, a way of helping (ministering) to get the work done. Those who do administrative work are as important and helpful in serving the mission of the organization as any other staff person or volunteer. It takes a certain amount of administration to do any programming — it is a fundamental cost.

What are administrative costs? They are costs that are essential to the day-to-day operating of the organization. Administrative costs include

  • Fundraising: development staff, donor relations, annual reports, newsletters, appeals and event costs, proposal writing, website development and maintenance, marketing
  • Finance: bookkeeping, budgeting, reports to funders, annual audit
  • Office: rent, utilities, postage, phone, fax, copy machine, computers, software, office furniture and supplies, cleanliness, safety and security, e-mail accounts
  • Support staff: human resources, office management, salary and benefits coordination, reception, coordination of hiring’s, orientation, research on health insurance, workers’ compensation, information technology, and the like
  • Board relations: materials for meetings, meals, calls, planning and evaluation mechanisms and materials, support for the board chair, other reimbursements for board members
  • Other: various for each organization, but might include licensing, storage, distribution, membership dues, travel arrangements, and the like

You may be thinking, correctly, “Much of these costs are required to do our programs” and then, incorrectly, “Why not just put some of them into the program budgets?”

There is nothing wrong with dividing administrative costs over your programs, and most of us will continue to do that as we write proposals and track costs. However, unless all your programs are the same size and you can easily divide the costs, it takes a huge amount of time to allocate administrative expenses.

Those who do administrative work are as important and helpful in serving the mission of the organization as any other staff person or volunteer.

I propose that over time we begin to change the way we show administrative costs. Since administration serves the programs, and these costs are important and legitimate, why not show them separately and educate donors and funders about them? Ultimately you will save time and money by not having to figure out percentages of this and that and wondering where you can hide this expense or what to call that one. These are the costs we need to save the environment, put on a play, educate our children, end racism, stop war, and all the other things we do.

EDUCATING DONORS

A large part of educating donors about how your organization spends money is to add some narrative to your numbers. So often in an annual report or even a budget report to a board meeting, the numbers stand on their own or are footnoted with cryptic phrases that are supposed to explain certain costs. For people who really understand budgets and are familiar with costs related to running a nonprofit organization, these reports are like a short story — they are interesting and coherent. But for the vast majority of people who are either not good with numbers or not familiar with what nonprofits need to spend, the numbers are a mystery. A layperson trying to make sense of numbers just makes up their own story.

For example, in many programs salaries are the lion’s share of costs. Over and over I have heard donors say, “They spend so much on salaries — can’t they get volunteers?” Or, looking at a line item such as office supplies, “Can’t people bring stuff from home?”

Here are some examples of adding narrative. One board chair wrote the following letter, which appeared in an annual report next to the letter from the auditor:

Dear Friends,

When I first came on the board of the Urban Green Project, I had no idea how to read an audit. I have learned a lot since then, and I always breathe a sigh of relief when the auditor gives us a clean bill of health, as he has this year. But these numbers mean so much more to me now than just showing we have spent our money legally and are following Generally Accepted Accounting Principles.

As an example, let me take just one cost: administration. We have one staff person, Sharon, who is the receptionist, bookkeeper, and grants administrator. She greets everyone as they come in, routes phone calls, answers or routes e-mail and mail, all while getting everything ready for the accountant and making sure our foundation funders get the information they need.

When I went into the office yesterday Sharon was showing some senior citizens how to use the Web to find out what exactly is in the pesticide that was sprayed on the lawn of their assisted living facility and whether it could have made them sick.

When people ask us to separate administration and program costs, I think of Sharon. The fact is, there is no effective program without administration, and there is probably no effective administrator who is not interested in program work.

There are real stories behind all these numbers. I hope you will read our newsletter, visit our website, and feel free to drop by the organization’s office. After all, the numbers on the income side of this report include your donation, and your donations are what finance the stories we have to tell. And our stories, added together, accomplish our goals.

Thanks again,

Board Chair

Another organization drew a line from each of its budget items on its financial report to a brief description of each line item. Here are some of them:

  • Capital Improvement, $17,000: Made our bathroom completely wheelchair accessible, which was the final barrier to accessibility in our office.
  • Telephone, $12,000: Translate that into 20 calls received every day looking for information and advice, 20 to 30 calls made by staff and volunteers every day setting up workshops, talking with experts, checking facts, finding out what is happening with various bills in the Assembly, getting price quotes, talking with donors. A total of 5,200 calls received and more than 4,000 calls made.
  • Information Technology (internet service, website maintenance, computer problem solving), $2,500: With e-mail and the Web, we have been able to cut our phone bill in half while responding to questions and receiving information from all over the world. Here’s just one e-mail exchange: A World Vision volunteer from Honduras
    asked a number of questions about lead paint. Since our manual, “Get the Lead Out,” is on our website, we can lead him to it much more quickly and far more cheaply than it would have cost to send him the report by mail. He translated part of the report into Spanish and then sent us his translation, in case we ever need it. Two days after we
    received his translation, we had a called from El Paso needing information in Spanish on lead paint removal Another organization drew a line from each of its budget items on its financial report to a brief description These stories give some depth to the numbers, without requiring that the organization decide what percentage of the $2,500 they spent on information technology should be allocated to program expenses and what percentage represents administration.
Administration is a behind-the-scenes cost, but it should not be a hidden cost.

Realistically, of course, most nonprofits are going to have to continue to figure out what costs are administrative and what are program expenses. Sometimes the cost distinctions are obvious, sometimes they are arbitrary. But what we want to do overtime is to educate current and prospective donors about what we do and how much it costs.

We begin by educating ourselves to the fact that administration is as noble a cost as are meals for the hungry or counseling for the suicidal or organizing testimony to be given at the City Council meeting. Administration is a behind-the-scenes cost, but it should not be a hidden cost. And as with much of life, the quality of any organization’s programs cannot be measured simply in dollars and cents.