NEW YORK (MainStreet) — We work hard for our money, so when we give to charities, we want our money to work hard, too. If we are going to choose between providing food to the homeless or paying for a nonprofit's office supplies, most of us would choose the former.
The so-called overhead ratio indicates how much money a nonprofit spends on direct aid compared to administrative costs. Many websites like Charity Navigator list a nonprofit's administrative expenses, and the prevailing assumption is, the lower the better.
After all, who wants to pay for a nonprofit's office space when the money could be helping the masses?
Not so fast, argues The Overhead Myth, a new website that helps people direct their philanthropic efforts.
Richard Johnson, CEO of nonprofit Spark Ventures, which helps children in developing countries by creating a pathway to financial sustainability for the grassroots organizations that serve them, has experienced this bias firsthand.
"After spending the first half of my career working in the private for-profit sector, I transitioned to becoming the fulltime CEO of a 501(c)(3) nonprofit," Johnson said. "As someone with an investment-minded approach to my work, I was discouraged to learn about the ways in which charities were basically penalized for investing in infrastructure, hiring talented staff and prioritizing cash on reserves."
Steven Wray, founder of nonprofit Restore Global, which redistributes excess goods when one nonprofit receives contributions it can't use fully, agrees.
"What if we were to use the same criteria toward many of our common purchasing decisions?" Wray asks. "In our children's daycare, we would ask, 'How much of the weekly tuition was directly used for the care of my child?' We would ask how much the owners and staff made in salary. After our research, [would we] conclude that the five-star daycare center was spending too much on administration and choose the 95-year-old lady who is caring for five kids in her 1,500 sq ft home next to the train tracks?"
In 2010, market research firm Grey Matter collaborated with charity consulting firm Russ Reid Company on an extensive study of donors.
"One thing we asked donors to do was to make some trade-offs, the kind of thing they have to do in their everyday decisions," says Ron Sellers of Grey Matter.
The survey asked consumers if they'd rather support an organization that spends fewer donor dollars on salaries but hires less-experienced or less-capable managers (resulting in less efficient or effective management), or an organization that hires top-quality managers but spends more on those salaries.
"Donors were really split over this," Sellers says. "40% preferred spending less money on managers, 38% preferred more experienced managers who are more expensive and 22% had no preference."
According to The Overhead Myth: "Under-investing in administrative costs is consistently linked with poor organizational performance and sustainability—trapping organizations. In our view, as long as these expenses support a nonprofit's mission and goals, they should be considered reasonable."
GuideStar contends that spending waste is less of a problem than many donors believe. Its data shows that only 6.8% of Form 990-filers reported spending more than 50% of their income on overhead in 2011.
If you're worried about fraud, you might find more information outside of the overhead ratio.
"Except in egregious examples, the overhead ratio tells you very little about fraud," the Overhead Myth website states. "If you're concerned about fraud, you should speak with the nonprofit you are researching and ask others about their experience with that nonprofit. Ask the nonprofit to explain how they plan to use your donations and how they have used donations in the past. Review their website for results reporting, and ask to read their annual report."
"Very few institutions can squeeze as much out of a dollar as the average U.S.-based nonprofit," GuideStar says. "GuideStar recommends reviewing a nonprofit's IRS Form 990 for any red flags, and above all having a conversation with the organization. Good nonprofits are transparent about their business practices and will start a long-term dialogue with you about their inner workings."
Administration vs. Fundraising
One significant distinction is between administrative and fundraising costs. The former includes hiring talented staff and deals with business management practices, while the latter is based on spending money to make money. Both of these expenses are necessary to support most charities, but GuideStar's Overhead Myth campaign is "primarily concerned with correcting the assumption that low administrative costs are inherently desirable," says the website. "Fundraising expenses, while also crucial to most nonprofit organizations, are more complicated. While there is no doubt that it takes money to raise money, there may be times in which the fundraising costs per dollar raised reach proportions that are beyond a donor's comfort range."
In other words, fundraising expenses may be more subjective. Do you think it's a good use of money to pay people to stand on the street asking for donations? Although this might feel gratuitous to you, does that practice bring in a lot of revenue?
"The vast majority of nonprofits do not spend unreasonable amounts of fundraising, and their fundraising investments yield considerable results for their mission and programs," GuideStar notes.
So How Should You Judge a Nonprofit?
We'd love to say there's a silver bullet, one stat you can view for a bottom-line yea or nay on whether you should give. But there isn't.
As we've discussed, judging an organization on how much it spends administratively isn't a good indicator of whether it does good work in its community, whether it's well-run, whether it actually helps people. Instead of harping on administrative costs, look at a charity's transparency—how open it is about its methods and accounting—governance, leadership and results.
As a donor, you have the right to read an organization's Form 990, the IRS filing that details its financial records. You can track this down with resources like the Foundation Center's 990 Finder, Charity Navigator or GuideStar. You can learn more about how an organization is run by requesting the nonprofit's annual report; look at who sits on the board, how long the board members have served, whether any of them have had legal issues lately, what the charity's future plans entail, etc. For a sense of an organization's results and reputation, check out Philanthropedia or GreatNonprofits, which feature crowd-sourced input and reviews.
"Much as it would be nice to be able to look to one simple number to determine how to give our charitable dollars, it simply doesn't exist, and probably never will," the Overhead Myth's website says. "You can't judge a company or a university or a person by one statistic, and the same is true for nonprofits."
—Written by Allison Kade for MainStreet