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 CalNonprofits CEO Jan Masaoka shares her take on how unreasonable overhead rates hurt nonprofits, donors, and communities:

Imagine I went to Starbucks and ordered a latte -- priced at $2.00. "I only want to pay for the coffee, the cup, and the time it takes you to make it," I say. "I don't want to pay for the rent, insurance, accounting...basically, I don't want to pay for your overhead. I'll pay $1.30, but that's it."

Starbucks would be well within their rights to kick me out!

Q: So what does this have to do with nonprofits?

Well, when funders say, "We want to support your innovative program for children with disabilities, but we don't want to pay for your rent, insurance, accounting or any overhead". . . we nonprofits don't usually kick out the funders. Instead -- because we desperately want to help children with disabilities -- we say, "okay."

(In fact, we usually say, "Thank you so much for your generous funding!")

Of course, a portion of the rent, insurance and accounting is part of the cost of both the Starbucks latte and the nonprofit program for children. Starbucks adds up the direct costs, the overhead and the profit margin to determine the "price." In the nonprofit community, we add up the direct costs and the overhead to determine the "full costs," "fully loaded costs," or simply the "real costs."

Q: I get the point. Maybe funders and donors should pay the "real costs." But if they don't, the nonprofit at least gets some funding. What's wrong with that?

Good question! The term "overhead" originated in manufacturing, where costs are identified as materials, labor, and [the factory] overhead: literally the factory over-the-heads of the workers. A company with prices below their full costs will still have to buy materials and pay workers, so they will have to cut overhead. And soon they will have a leaky roof, obsolete equipment, and inadequate insurance.

For nonprofits, under-funded overhead typically results in:

  • Inadequate and obsolete facilities, equipment, and technology
  • Under-staffed accounting, HR and administrative offices, resulting in reduced ability to deliver programs, manage funds, raise other funds, and document results
  • Lack of continuing education and training for staff, resulting in higher turnover and lower quality of services
  • Ill-advised decisions

Q: Can you give me an example?

Sure! We know one food bank that had larger numbers of people needing food, and fortunately also was receiving more donations of food. They ran out of warehouse and refrigeration space. All staff doubled up in small offices to make more room for food. Clearly they needed a larger facility for both storage and distribution.

But a larger facility would mean higher overhead costs. The nonprofit's board and staff leaders worried that higher overhead would alienate donors. They worried that they wouldn't be able to raise additional monies from foundations and government funders that don't want to pay for overhead.

So they decided to stay where they were. Over time, the cramped offices made staff grumpy and increased employee turnover. As more clients came, they had to wait in longer lines. The nonprofit sometimes had to turn down donated dairy products and vegetables due to lack of refrigerated storage.

But they kept their overhead down!

Q: Well, that's an example using a building. Isn't it reasonable, though, for a funder not to want to pay for bureaucratic layers of unnecessary administrators?

Yes, that is reasonable. No one wants unnecessary expense. What makes this a problematic request is that what looks like necessary supervision of caseworkers to one person looks to another person like unnecessary bureaucracy. What looks like necessary security precautions in an art museum looks like unnecessary administrative procedures to another.

Q: I can see why nonprofits want adequate overhead for their programs for their communities. But you said that under-funded overhead also hurts funders. How?

Let's take a situation where a funder -- let's say a local government -- is funding a whole program; let's say $150,000 per year for senior activities being delivered in a community center. But let's say that the senior program costs $190,000 per year when its share of the facility and other overhead costs are accounted for.

The nonprofit has to raise another $40,000 to keep itself from going broke on this senior program. Essentially, its other donors -- such as foundations and individuals -- have to subsidize the senior program because government isn't paying the full costs. Some of these donors and funders want to support the community center as a whole, including its other programs and its role in bringing together the community. Instead, many of their donations will have to be used to subsidize this one program.

Q: That makes sense. When the government buys a ream of paper, they have to pay the full costs of the paper, and they should have to pay the full costs of a program where they're basically buying the services.

Exactly.

Q: But what if I'm making a personal donation to, for example, an environmental health advocacy nonprofit? If I make a $50 donation, are you saying I should actually be giving them more to take overhead into account?

I'm sure they would appreciate a bigger donation! But you shouldn't feel you have to take overhead into account when you're making a donation or gift. If, for example, you give your nephew $40 for his birthday, you have given him a no-strings-attached gift. But if your nephew is a carpenter and you hire him to build a TV cabinet for you, you owe him a fee that takes his overhead into account.

Q: Getting back to the main topic, now I see how misconceptions about nonprofit overhead actually have a negative impact on nonprofits and what they do.

Just to recap, these negative impacts typically include:

For the nonprofit:

  • Lower productivity and substandard physical conditions due to under-investment in facilities, equipment, and technology
  • Diminished accountability and oversight due to inadequate spending in accounting, HR, facilities management, and other necessary administrative functions
  • Lack of continuing education and training for staff, leading to lower quality and higher turnover
  • Increased financial vulnerability
  • Poorer choices available for decisions due to lack of financial flexibility
  • Fewer people served and/or diminished quality in services and products due to inadequate payments

For funders:

  • Risk of grants and donations being used to subsidize government-based programs
  • Diminished ability of nonprofit to perform at levels of excellence, to manage finances appropriately, and to document results
  • A weaker network of providers in a given field, such as domestic violence or wildlife conservation, making it harder to find strong partners

For the community:

  • Essential human services may be offered at lower levels and put at risk as providers struggle to provide quality services with inadequate funding
  • Gaps in quality control and compliance are more likely to occur with under-funded administration
  • Education, health and human services may be offered in substandard facilities
  • More frequent failures and less healthy systems of innovation and delivery in nonprofits of all types, eroding the ecosystems in arts, environment, health, and other fields

Q: So what can be done about all this?

See the rest of the Nonprofit Overhead Project website and find all the resources you need!

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May 11 - Thursday, Session 1
Real Costs – Realistic Strategies: Understanding, Communicating, and Funding the Full Cost of Your Services

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Recovering Overhead Costs in Government Contracts: New Opportunities

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Negotiating a Federal Indirect Cost Rate: Step by Step Guide to Preparing Your Indirect Cost Rate Proposal
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