Nonprofits often get asked about their overhead expenses. Overhead costs and overhead rates can mean different things to different people. What’s a program cost is to one is an administrative cost to another. But what really matters is how the IRS categorizes expenses for nonprofit organizations.
All expenses fall into one of three categories on the IRS Form 990:
· Program Service Expenses
· Fundraising Expenses
· Management and General Expenses
Now, this is where math is involved but the formula to calculate your overhead rate is simple. For example, if you have $15,000 operating expenses (management and general plus fundraising) and $75,000 total expenses, then your overhead rate is 20%.
Overhead rate formula:
Management and General Expenses
+ Fundraising Expenses
Divided by Total Expenses = Overhead Rate
So, what’s considered a “good” rate? The Better Business Bureau uses 35% as their baseline while Charity Watch gives a poor rating to nonprofits with 40% or higher overhead rates. Currently, the rule of thumb is that an overhead rate should be 35% or less.
Here’s a link https://www.irs.gov/pub/irs-pdf/f990.pdf to the IRS Form 990 so you can locate the correct numbers. Look under Section IX, Statement of Functional Expenses.
This section includes four columns:
(A) Total Expenses
(B) Program Service Expenses
(C) Management and General Expenses
(D) Fundraising Expenses
An easy mistake to make when tracking expenses is with salary allocations. For example, the role of a receptionist may seem to be all administrative but in reality, this person may also have program duties and play a part in delivering services. Your budget and other financial records should reflect a percentage of the receptionist’s salary under programs and administration.
Your accountant or bookkeeper should be informed of how salaries and other expenses are to be allocated among these various expense categories.
Don’t be afraid to invest in your organization and have appropriate overhead rates. Failure to balance the need for program funding and overhead costs have can a huge negative impact for nonprofits such as increased staff turnover, poor program delivery, outdated technology and limited ability to expand services.
I’m working on a companion article to dive into overhead myths and how nonprofits can better explain the need to invest in appropriate overhead costs to grow your organization.
Understanding how overhead costs are allocated and following best management and accounting practices will help you and your nonprofit organization be successful.
Michelle Crim, CFRE
Dynamic Development Strategies can help. We offer coaching and fundraising services for our nonprofit clients. We specialize in startup and smaller nonprofits because we understand your challenges. Please contact us for more information.