Beyond “The Overhead Ratio” Part 2: Four Ways Nonprofits Can Effectively Illustrate Their Impact

In order to ensure that their dollars are being used as intended, donors have a responsibility to research nonprofits before choosing whether or not to support their work. But it is up to nonprofits to be able to communicate their programs, financial information, governance, and impact in a transparent, accessible, and meaningful way.

As we discussed a few weeks ago, the “overhead ratio” is a common measurement used by donors to determine whether a charity is efficiently using donor dollars. The ratio, or “Use of Funds” as we call it at the Charities Review Council, is the percentage of nonprofit expenses that go to administrative and fundraising costs. It is public information that is simple to calculate and easy to understand, but alone, it is a poor measure of an organization’s performance.

The ratio serves as just one way donors and nonprofits seek to establish a trusting relationship. Donors want to know that their hard-earned dollars are being put to good use. But as Council Associate Director and finance guru, Amy Sinykin, points out, “the calculation of this ratio is more of an art than a science.” The way that an organization allocates its expenses to program, fundraising, and administrative buckets is not well-regulated or standardized.

Though the IRS provides some guidance, there are different means of calculating a nonprofit’s financial ratio, according to Nonprofits Assistance Fund (NAF). Some organizations may code every working hour of each employee as time and money spent on programming, fundraising, or administration. Others might just estimate their annual staff time allocation based on a two week sample. Furthermore, some guidelines suggest that volunteer management be considered fundraising expenses and others recommend that it fall into the program or management bucket. Consequently, it becomes difficult to attempt to compare nonprofits and the efficiency of organizations based solely on this number.

In an interview with Social Velocity, Kate Barr, the Executive Director of NAF, said “that the functional expense ratio doesn’t measure nonprofit effectiveness, efficiency, or accountability. The challenge now is communication and education.” Moving beyond the overhead ratio will require active engagement on the part of both donors and nonprofits to develop a new vocabulary for evaluating the work of nonprofits.

Nonprofits must direct adequate resources to core infrastructure and capacity building activities such as evaluation, staff development, planning, IT systems, and financial and human resources management to continue furthering their respective missions. However, this does not mean that funneling financial information to fit within the confines of a ratio suffices as a means of providing donors with information about the work of an organization.

Dan Pallotta, author of Uncharitable: How Restraints on Nonprofits Undermine Their Potential, says “The question that is completely overlooked, of course, concerns the charity’s effectiveness in achieving its mission—in other words, how good is it at doing what it’s supposed to be good at? With the money it has for the needy, how well does it serve them? How effective is its approach?” For example, Pallotta points out that Soup Kitchen A could use 90% of a donation to directly support their cause, while Soup Kitchen B uses 60%. Soup Kitchen A would appear to be a more efficient organization on paper, but Pallotta says this measurement ignores whether or not each organization is providing nutritional soup in a clean environment. Soup Kitchen B provides superior services, however, is at risk of being sidelined because too many people rely solely on the ratio concept.

It is up to nonprofits to encourage donors to look beyond this measurement to see the true impact of an organization.

Here are four ways nonprofits can talk about their impact, beyond “the overhead ratio”:

Educate your donors: Link to our donor post in your next e-newsletter or write an article for your print newsletter, urging your supporters to move beyond the ratio towards a better understanding of nonprofit impact.

Build trust: Consider including a note from your Executive Director describing your use of funds on your website. Answer the following questions: Why is your ratio different than other nonprofits? Are you undergoing change? What about your programming requires this breakdown of expenses? What about the new nonprofit landscape has created this shift? What is your community impact as a result of your budget?

Be transparent: Include narrative explaining your financials in your annual report, encouraging donors to ask questions. Consider posting a Financial FAQ page on your website to clear up any questions or confusion.

Have conversations: Use social media, phone calls, meetings, and conferences to talk about your organization’s impact or why it’s use of funds might be questioned by a donor. Write a blog post about what makes you an outlier to that standard '70/30 split' and we’ll post it on the Smartgivers blog to share with readers!

In order to continue making a positive impact within communities, both donors and nonprofits need to look beyond “the overhead ratio” when considering the effect of the initiatives championed by nonprofits.

By Keely Hendrickson, Marketing and Development Specialist

What We’ve Been Reading...

The Charities Review Council whole-heartedly believes in sharing valuable knowledge, news, and resources – known as Sector Moments around our office. Here is what we’ve been reading this week:

#NextGenDonors

The Next Gen Donors report, a collaboration of 21/64 and the Dorothy A. Johnson Center for

Philanthropy, strives to paint a picture of Gen X and Millennial donors – a relatively small group of individuals who will inherit over $40 trillion. "Today’s younger generations have the potential to be the most significant philanthropists in history. But we don’t know much about them." Baby Boomers no longer make up the majority of the giving population. Next Gen Donors gives us the unprecedented research to gain understanding about the values, expectations, and goals for these 21st century philanthropists.

Three Big Ideas for Designing Innovations to Work at Scale

Though this article from Stanford Social Innovation Review focuses on higher education, many of the ideas are applicable to nonprofits, as well. With the “innovation” buzzword being thrown around left and right lately, it’s important to take a step back and determine what realistic innovation really means for your organization. “Campuses across the country are littered with the failed remnants of excellent innovative projects that died because there was never genuine buy in, real financial and institutional support, or a hospitable policy environment.” Check out this article for insight into smart innovating on the right scale.

Families on Boards: What’s the Rub?

A recent report by the St. Louis Business Journal notes the saturation of family members and a few select individuals’ on numerous nonprofit boards in the St. Louis area. Initially, this might not seem like such a big deal, but Eileen Cunniffe of Nonprofit Quarterly outlines the issues with this situation – like the true commitment required to be an effective nonprofit board member, and confusing status and/or wealth with good governance. A great case for the necessity of board term limits, this is a quick, must-read for nonprofit leaders, current board members, and individuals interested in joining a board. 

It can be difficult to find the time to scan the headlines, but setting aside a few minutes each day to read up on the latest happenings in the global nonprofit and philanthropic community can be inspiring, motivating, and educational.

We hope you find these reads interesting and helpful!

Beyond “The Overhead Ratio” Part 1: Five Ways Donors Can (and Should!) Evaluate a Nonprofit

The percentage of expenses that a nonprofit spends on administration and fundraising is a hotly contested topic. For some time, the “overhead ratio” has been used by donors to determine whether or not a charity is effective and worthy of a donation. The number itself is easily calculated, accessible, and well-understood. But this measure does not tell the whole story and is an insufficient means of evaluating nonprofits.

On June 17, 2013, the BBB Wise Giving Alliance, Charity Navigator and GuideStar wrote an open letter to American donors highlighting the importance of not depending solely on “the overhead ratio” as a measurement of a nonprofit’s effectiveness when considering giving to the organization. 

“The percent of charity expenses that go to administrative and fundraising costs—commonly referred to as “overhead”—is a poor measure of a charity’s performance. We ask you to pay attention to other factors of nonprofit performance: transparency, governance, leadership, and results.”

This letter joined an evolving nationwide conversation about how to evaluate the work of nonprofits. While it is important to examine how a nonprofit disperses its funds, it is time we, as a sector, define a better way to measure the effectiveness of nonprofits. The way a nonprofit communicates, its governance, and infrastructure are all important factors that should be considered before making a donation. 

Here are five ways you can get the full picture of nonprofit effectiveness:

1. Does the nonprofit have a positive impact on the community? Review the organization’s Annual Report to determine if it clearly states its strategic goals, provides information about the mission, and outlines the direct results achieved in the community. Annual Reports should be available on each nonprofit’s website or by request.
2. The leadership of a nonprofit is an important area to research. Take the time to get to know the staff and board members of an organization by reading about them on their website, newsletters, or other published materials. Do not hesitate to call the nonprofit directly with your questions. 
3. To learn more about how your donation will be used by the nonprofit, review their 990 and other financial documents to learn about their expenses and how their programs are funded. It is important to look at all the numbers, not just the ratio of expenses.
4. How can you be sure that funds raised are actually going to their programs and other initiatives? Check to see if the nonprofit’s solicitations include the following information: confirmation that the nonprofit is the recipient of the funds, a description of programs enhanced by the funds or purpose of the funds being raised, and the nonprofits telephone number or address. Always feel empowered to contact the organization to learn more about this information.
5. Choose to support those causes working toward improving an issue area that you are passionate about. Your support for a nonprofit does not need to end when you sign a check. Volunteering for an organization is a great way to get a clear understanding of how it operates. Engage with the charity by having conversations and asking questions. Sharing your passion with others can create an engaged community and raise awareness about the work of the nonprofit. As the millennial generation emerges to form a strong group of informed donors, the prevalence of social influence will help to build support for the work of nonprofits.

To learn more about evaluating nonprofits, check out the Charities Review Council’s Accountability Standards®. These 27 Standards of governance, fundraising, financial activity, and public disclosure help to strengthen nonprofits’ commitment to accountable practices and provide meaningful information to the donating public in order to advance more informed philanthropy.

As a donor, you have the opportunity to help strengthen communities by supporting the work of nonprofits. By looking beyond the overhead ratio and striving to get a clear, true picture of an organization’s impact, donors can begin to build trusting, open, and truly world-changing relationships with nonprofits.

Do you work for a nonprofit? Make sure you read the second part of our series: Four ways nonprofits can communicate their impact to donors - beyond the overhead ration.

By Keely Hendrickson, Marketing & Development Specialist and Brita Midness, Engagement & Marketing Intern

Red, White and Blue: Our Culture of Philanthropy

(Photo Credit)

With the Fourth of July right around the corner, we are taking a moment to reflect on the culture of philanthropy here in the United States. As we open our front doors tomorrow morning to the sounds of parade preparations and music wafting from the bandstand, the sense of community that we feel on a daily basis will suddenly appear in full regalia as a sea of red, white, and blue covers neighborhoods across the country. The many cultures and communities that form the United States are strengthened by our vibrant and thriving nonprofit sector.

Tomorrow, people all across the country will come together to spend time with family and friends, forming one large community, spreading across fifty states, and woven together by a diverse array of experiences. It is this rich array of experiences that serves to strengthen our nonprofit sector, as positive change stems from our ability to come together to find innovative solutions that transcend boundaries. Along with the country as a whole, our thriving nonprofit sector has also evolved and grown over time. According to the National Center for Charitable Statistics, the number of nonprofit organizations has steadily increased, with 32.7% more nonprofits in existence in 2008 than in 1998. As our country grows and changes, nonprofits must continue to evolve to meet the complex and varying needs of each community.

Often, the nonprofit sector is associated with money - donors looking to financially support a cause they are passionate about or nonprofits working to disperse funds to those in need. In 2011, a total of $217 billion was given by individual donors over the course of the year. However, Americans give not only with their money, but also with their time, knowledge and expertise. For example, between September of 2009 and September of 2012, “26.5% of Americans over the age of 16 volunteered through or for an organization”. Volunteers work alongside other members of the nonprofit community to achieve common goals. On Independence Day, people all across the United States also find a common cause around which to celebrate. This sense of community is something that can be carried forward as we strive together to enhance the work of nonprofits in our communities across the United States.

The United States plays host to an extraordinary number of nonprofit organizations, which together form a strong sector that accounted for 5.5% of the GDP in 2012. The United States has long been known as an arena where nonprofits can emerge and thrive. This shared sense of community and a commitment to positive change has the ability to reach across the invisible borders that define countries and play a key role in global civil society. As best practices in the nonprofit sector emerge across the world, it is important that we learn from and collaborate with each other to work towards the common good. 

As the Fourth of July arrives, take the time to reflect on what is important to you and how you can make a difference in your community.

By Brita Midness
Engagement and Marketing Intern