Nonprofit overhead is a prevalent and controversial topic in the nonprofit and philanthropic sector (Bedsworth, Gregory and Howard 2008; Garven, Hofmann, and McSwain 2016; Gregory and Howard 2009; Lecy and Searing 2015; Smith and Lipsky 1993; Wing et al. 2006; Wing and Hager 2004). Online raters (such as Charity Navigator) point to the overhead rate as a key indicator of nonprofit worthiness. Different government entities use wildly different indirect cost rates when contracting with nonprofits, which translate into billions of dollars of funding being gained or lost (Urban Institute 2013; Ling and Roberts 2017). Foundations rarely have explicit guidelines, but most have informal rules of thumb that affect how a nonprofit can use grant funds (Gregory and Howard 2009). Meanwhile, nonprofit executives “play the numbers game” (Garven, Hofmann, and McSwain 2016) and struggle to make sense of it all as they manage their operations amidst the conflicting requirements of their funding sources (Chen and Krauskopf 2009; Garvin, Beck and Parsons 2017; Gronbjerg 1993).
Successful contract and grant management by nonprofits – in scenarios where contracts and grants do not cover the overhead cost of the contracted services – can feel as if they are sitting on a two-legged stool. It is possible to balance, albeit not easily, as the stool is always at risk of falling over. So how are nonprofits managing to balance on this two-legged stool without the necessary resources and capacity for operating costs, staffing, financial oversight and management, insurance, facilities, technology, and other necessities? This research attempted to gain a better understanding of nonprofit overhead in California, specifically addressing the following questions:
How are nonprofits in California funded?
How are overhead and indirect costs 1 defined, viewed, and interpreted by different stakeholders (i. e., foundations, donors, various levels of government)?
What overhead rates are acceptable by foundations, donors, and various levels of government?
How do overhead rates affect nonprofits’ internal management, policies, finances, reporting, and programs?
What messages about overhead can nonprofits effectively use to support adequate funding of their overhead costs?
In order to address the research questions, the California Association of Nonprofits (CalNonprofits) collected data from two different samples using two different methodologies. 2
First, an online survey was sent to the CalNonprofits electronic mailing list in the spring of 2016, with a request to forward the survey to other California nonprofit executives. The survey included questions related to: (1) funding sources; (2) experiences with government indirect cost rates and the new Office of Management and Budget (OMB) Uniform Guidance 3; (3) experiences with overhead and indirect costs in foundation grants; (4) how overhead and indirect costs are discussed with funders; (5) how overhead and indirect cost rates influence management decisions; and (6) organization demographics.
Second, in-person interviews were conducted with ten elected members and/or their staff of six county boards of supervisors throughout California in the spring of 2016. California counties are governed by elected boards of supervisors, and the counties represented were Alameda, Contra Costa, Fresno, Los Angeles, Riverside, and San Francisco. These in-depth interviews included questions about: (1) how they defined overhead; (2) their opinions about acceptable levels of overhead for nonprofits; (3) their familiarity with the new OMB Uniform Guidance and whether it was being implemented in their county; and (4) testing different messages nonprofits might use to make a more convincing case for funding overhead costs.
This section summarizes the key findings, along with verbatim quotations (presented in indented text) from nonprofit executive respondents.
Profile of Participating Nonprofit Organizations
A total of 451 valid surveys were completed. The majority of respondents were executive directors (52 %) or senior finance staff (21 %). Although there was at least one respondent from 42 of California’s 58 counties, most respondents were from nonprofits in urban areas. Roughly one-half (53 %) of respondents represented five counties, including Los Angeles (24 %), San Francisco (9 %), Alameda (9 %), Orange (6 %), and Santa Clara (5 %). Organizational budgets ranged from a low of $0 to a high of $166 million, with a median of $888,000. Figure 1 shows the different areas of focus (i. e., subsectors) of participating nonprofits.
A Tangled Knot of Definitions and Understandings
One objective of the nonprofit executive survey was to better understand what overhead or indirect cost rates are acceptable by government, foundations, and individual donors.
What clearly emerged was that nonprofit executives reported such dramatically different definitions and calculation methodologies that “rates” became problematic to analyze. In fact, the degree of confusion was itself a major finding.
For example, Foundation A may view all personnel costs as overhead, while Foundation B identifies some staff as direct program costs and other staff as overhead, while Foundation C funds direct wages but views all fringe benefits as overhead. In this example, all three foundations might say they are funding a 10 % overhead rate, but actually they are funding very different percentages of the program’s costs.
Some foundations think we have a low overhead rate because we direct cost everything for them.
At first it might appear that government funding criteria are more clear because there are specific definitions and allowable methodologies for calculating indirect costs in contracts and grants. 4 However, this research found that these rules are interpreted differently by different government agencies and in different contracts. For example, indirect costs in Government Contract A may be calculated as a percentage of direct allowable salaries, while Government Contract B considers it to be a percentage of direct allowable personnel costs, and Government Contract C calculates it as a percentage of total direct costs. In addition, informal policies, situations, and relationships frequently override rules, again resulting in different government agencies simply allowing for different indirect cost rates.
We charge all government contracts 8% indirect, but we charge rent, insurance, accounting ‘above the line’ as direct costs.
I am the rope in the tug-of-war [between] what grantors want to see on financials and how our accountant sees classing of expenses.
If there is a line item for overhead, then monies are taken away from project/program delivery because there is usually a ceiling on monies awarded. Unfortunately, it’s just a “shell-game.”
The complexity created by multiple definitions and allocation methods can result in funders not understanding what they are paying for, or the consequences of their funding restrictions.
Trying to get all types of funders, regulators, nonprofits and individual donors to agree on definitions is probably an unattainable goal. But in the meantime, all findings about nonprofit overhead – including those from this survey – need to be strongly qualified with the caveat and understanding that people are using the same words to describe very different cost groupings.
Multiple Funders = Multiple Cost Systems
This research found that a high percentage of nonprofits obtain funding from multiple types of sources, requiring them to track and report costs very differently to different types of funders. This is a significant challenge, given the additional time and resources needed to meet these requirements.
Because of the 2.5% limit on overhead costs by [federal funder], we’re forced to operate under two fiscal systems.
Figure 2 shows what types of funding nonprofits report as a significant revenue source for them. In sum, most nonprofits were highly affected by indirect cost rate parameters from multiple institutional funders, given that:
55 % of nonprofits received significant funding from private foundations
40 % received significant funding from community foundations
30 % received significant funding from county government
26 % received significant funding from each of the following: city government, state government, and federal government
Many government contracts also take the form of fee-for-service contracts. Typically, a per-unit cost is calculated based on direct costs and some amount of indirect costs resulting in a rate such as $3.40 per meal delivered to a senior. Fee-for-service contracts were not explored in depth in this study, although many respondents commented that fee-for-service rates may at one time have included some funding for overhead. However, respondents also noted that fee-for-service rates quickly fall well below the actual costs because rates often stay the same for five or ten years.
The issue that impacts us most is that [fee-for-service rates] fail to keep up with rising expenses.
Government Funding and Indirect Cost Rates
After further analysis of government funding, this research found that slightly more than one-half (55 %) of nonprofits reported receiving funding from at least one level of government, and 15 % of those organizations received funding from two or more levels of government. The median number of government contracts was three.
Respondents were asked to report on their last two contracts from each government level and, as can be seen in Table 1, a total of 670 contracts were reported. Table 1 also shows that most (65 %) federal contracts were less than $300,000, with 45 % of contracts that size having indirect rates in the 10 % to 15.9 % range, although another 42 % had indirect rates less than 10 %. State contracts followed a similar pattern, where 63 % of state contracts were less than $300,000. More than four out of ten had indirect rates between 10 % and 15.9 % (42 %) or less than 10 % (45 %). County contracts were the most frequently reported, again mostly below $300,000 (68 %). Of these, 45 % of contracts had indirect rates less than 10 %, and 40 % had rates between 10 % and 15.9 %. The majority (87 %) of city contracts were also less than $300,000. One-half (49 %) of these contracts had rates less than 10 %, and 39 % had rates between 10 % and 15.9 %.
Overall, Table 1 indicates that the indirect rates vary a great deal for all contract sizes across all levels of government contracts – thereby adding to the complexity, confusion, and added burdens of working with multiple government (and other) funders.
More reporting and compliance requires more management salaries and expense, which reduces the amount of money that actually touches the client.
This “transition” year has been extremely challenging! We’ve had to deal with grants that don’t apply to the new OMB, and new grants that do apply but with different interpretations of the OMB rules. We finally got the approved NICR after waiting almost five months, and we are now having to modify all our budgets so we can use the rate, with only two months left in our fiscal year!
Funders and grantees need to get on the same page with all of this overhead stuff. They are not speaking the same language which makes for disjointed relationships and expectations.
It is sometimes more trouble to track admin costs vs. just raising general operating dollars … keeping track [of] every grant contract is difficult.
OMB Uniform Guidance
One section of the new OMB Uniform Guidance mandates that all contracts that contain federal funding utilize an established Negotiated Indirect Cost Rate (NICR). Having a NICR has become increasingly beneficial to nonprofits under the new OMB Uniform Guidance because NICRs are typically substantially higher than rates determined at state and county levels. 5 However, as can be seen in Table 2, a small percentage of nonprofits had a federal NICR (8 %) or were in the process of obtaining one (2 %), and almost two-thirds (63 %) did not have a NICR or plan on obtaining one. Of those with a NICR, the rates ranged from a low of 2.5 % to a high of 75 %, with a mean of 13 %.
When asked how they are experiencing the impact of the new OMB Uniform Guidance related to indirect cost recovery in contracts with governments, one-half (49 %) of respondents reported their contracts were already in compliance, and another 20 % said they were planning to discuss the Guidance with their contract officers. However, another 15 % reported there is confusion and/or resistance from government contract officers and only 8 % said that their contract officers are knowledgeable about the Guidance (see Figure 3).
Local government says they never heard of such a thing.
Stipends paid to volunteers are excluded [from indirect cost rates]; 75% of the expenses in the contract are required to be spent on stipends. [In effect, indirect costs are only being paid on 25% of the contract.]
Pressure to Keep Reported Overhead Rates Low
Figure 4 shows that at least four out of ten respondents (for whom a source was relevant) indicated they feel pressure from their non-donor funding sources to keep their reported overhead rates low. These findings affirm previous research on the vicious “nonprofit starvation cycle” (Gregory and Howard 2009; Lecy and Searing 2015; Parsons, Pryor, and Roberts 2016) where funders reward low overhead rates, which pressures nonprofits to spend less on necessary overhead and report low (and sometimes misleading) overhead rates. In turn, such artificially low overhead rates result in funders expecting and demanding even lower rates.
Donors think they will force efficiency by limiting overhead, but it is ultimately less efficient for the organization to implement/track/monitor that kind of grant. Foundations efforts to “limit overhead” actually end up increasing overhead.
Making Ends Meet: Compensating Strategies
Three out of four (78 %) respondents said that government funding did not pay for the full cost of programs. When asked how they compensate for the gap between the actual costs of a program and the allocated funding, nonprofits reported managing with multiple simultaneous strategies. In some cases (and to varying degrees), these strategies included leveraging resources from outside the organization. But perhaps more telling are the internal strategies they reported using that are not likely to be sustainable over time. These strategies are consistent with recent literature (Marwell and Calabrese 2014; Parsons, Pryor, and Roberts 2016; Sloan, Charles, and Kim 2016), and are summarized below in Table 3.
The contracts all require matching funding and none covers all administrative costs.
Some do [pay the full costs]. Some don’t. It depends on the agency within the government.
In addition, many respondents commented that while low overhead rates may not result in cutting services, such rates prevent them from expanding services. For example, a nonprofit may be able to raise $100,000 to cover the gap in a government-funded program, but they may have to turn down the government’s request to double the program because they don’t think they can raise $200,000.
We were about to turn down a corporate contract – which is for a great program that will benefit the community immensely! – because they offer only a 5% indirect rate. However, we will probably take the contract and then be forced to collect proportionately more overhead from funders with less robust reporting requirements.
We are currently deciding whether or not we can afford another city contract without increasing admin/overhead. We might end up needing to turn it down, which is very sad for our homeless neighbors.
Communicating to Government Funders and Partners
In the context of inconsistent implementation of the OMB Uniform Guidance, and with most government-nonprofit contracting occurring through county governments, the interviews with county supervisors revealed the following findings. First, supervisors were often unaware of how the overhead issue plays out in government-nonprofit contracting, and they rely heavily on departmental staff to develop and execute contracting policies. Second, supervisors perceived nonprofit contracting as a transactional business relationship, and viewed themselves as purchasing services and outcomes. Third, supervisors were not opposed to paying for “reasonable” overhead, which is understood to be a legitimate cost of business. Fourth, across the ideological spectrum, supervisors generally trusted nonprofits to be honest, and were more concerned with ineffective management than with dishonesty or malfeasance. Finally, wary of “spin,” supervisors reacted negatively to suggested alternative words such as “full costs,” “real costs,” or “foundational costs.”
Another objective of the interviews was to get supervisors’ reactions and feedback on different types of communications (i. e., messages) related to overheard and indirect costs. Four types of messages were developed and a brief statement related to each one was read to county supervisors. A summary of the findings for each of the four messages is presented below.
Performance-based message – the idea that “performance and outcomes are what counts, and overhead is necessary to achieve them” – was perceived the most favorably. One supervisor suggested that nonprofits say: “Hold us accountable to results, not overhead percentages.”
Fairness message – the idea that government should pay fairly for services – was the second most favorable type of message. The notion that government should pay overhead in nonprofit contracts – just as they do in contracts with for-profits – resonated especially well with supervisors more familiar with nonprofits. Yet for supervisors less familiar with nonprofits, this type of message was perceived as misleading and not as effective.
Basic cost message – using any term other than “overhead” or “indirect costs” made supervisors leery, although the idea of these types of costs made sense to them.
Flexibility message – the idea that nonprofits need overhead to remain innovative and flexible – tested poorly with supervisors.
When supervisors were asked to articulate the “best” argument for nonprofit overhead, they suggested ideas such as: “to keep nonprofits viable” and “to have the vital funding they need to keep alive.” Supervisors also emphasized the importance of messengers or “validators” who can attest to a nonprofit’s performance and serve as a proxy for performance instead of focusing on overhead rates. They suggested that recipients of services, unaffiliated community leaders, and other funders would be effective messengers.
Discussion and Implications
By documenting actual experiences and insights from California nonprofit executives in the real world, this research reinforced a growing consensus in the field that nonprofit overhead rates are problematic for nonprofit organizations (Garven, Hofmann, and McSwain 2016; Gregory & Howard, 009; Marwell and Calabrese 2014; Parsons, Pryor, and Roberts 2016; Sloan, Charles, and Kim 2016; Urban Institute 2013; Wing et al. 2006). Nonprofits are frequently unable to cover the full costs of funded programs and to bridge the gap, they have to accelerate their fundraising from private sources, reduce salaries and benefits, under-invest in facilities and technology, and spend down reserves. Moreover, the aggregated unnecessary time and resources associated with different definitions, calculation methods and terminology among nonprofits, funders, and policy makers set the stage for practical questions such as “How much confusion should nonprofits be expected to absorb?” and empirical questions such as “What are the actual expenses associated with this confusion?” and “Do these expenses result in discounting funds used for services?”
Overall, this research confirmed that nonprofits in California are managing to the best of their abilities, but with difficulty. With inadequate funding of core operating costs, nonprofits are sitting on a two-legged stool, having to work with diminished capacity in staffing, financial management, insurance, facilities, technology, and other necessities that are needed by the entire organization and its beneficiaries.
This research also revealed that nonprofit executives implement strategies for managing the pressure to keep overhead low, and some of these strategies negatively affect their organizations and work. The most common ways that overhead negatively influenced decisions were in staffing, program quality and expansion, and use of reserves. Ironically, the drive to keep overhead low – presumably to keep money in programs – resulted in diminished quantity and quality of programs and services.
The wide variety of practices uncovered in this study suggest that different approaches – both in strategies and communications – are needed for different audiences if more nonprofit contracts and grants are to cover the full costs of the programs funded. The Nonprofit Overhead Project will build on these findings to develop such approaches.
While the new Uniform Guidance from the OMB is moving in the right direction towards more realistic, appropriate overhead rates for nonprofits, this research revealed the uneven progress towards full implementation. Furthermore, attention to overhead has seen an important shift from thinking “the overhead problem” is an issue of insufficient nonprofit accounting expertise to a recognition that overhead is a larger systems concern and a significant public policy challenge (Wing et al. 2006). What is at stake is billions of dollars in nonprofit funding and quality programs and services that affect millions of lives.
Future Research and Inquiry
Although policy development is frequently studied and analyzed by researchers, the possible gaps between policy and implementation are less frequently examined. This study echoes previous literature (Chen and Krauskopf 2009; Garven, Hofmann, and McSwain 2016) which contends that while federal policies are highly developed and explicit, the fragmented and misunderstood way they are implemented across thousands of governmental bodies results in confusion and inconsistent policies that often prove detrimental to nonprofits.
This study, along with other work from The Nonprofit Overhead Project and other similar research (Lecy and Searing 2015; Ling and Roberts 2017; Brothers 2016) affirms that more research is clearly needed. Some specific questions that deserve attention by researchers and policy makers include the following:
Are these findings from California similar or different from other states across the country?
Does this self-reported data coincide with actual contract numbers, amounts, and overhead rates?
What are the specific consequences and implications of different city, county, state, and federal policies and practices across the United States on the nonprofit and philanthropic sector?
What are identifiable stages of implementation and typical timelines for implementation of federal regulations?
How can gaps between regulation and implementation be researched effectively?
How are changes in federal (and/or state, county, city) regulations on government-nonprofit relations communicated and monitored by federal (and other) regulators?
What are established best practices for disseminating information, and training and monitoring policy implementation in this decentralized environment with multiple decision points and decision-makers?
About The Nonprofit Overhead Project
The Nonprofit Overhead Project is an initiative of the California Association of Nonprofits (CalNonprofits) with multiple components, including other quantitative and qualitative research, work with the foundation community, development and delivery of finance skills workshops for nonprofits, an online Toolkit, and public policy work in the California state legislature and in select California counties.
Funders of The Nonprofit Overhead Project are the California Community Foundation, the California Wellness Foundation, First Five LA, the James Irvine Foundation, and the Weingart Foundation.
For more information, visit http://www.calnonprofits.org/programs/overhead
The authors would like to acknowledge Lake Research Partners for their work on many parts of The Nonprofit Overhead Project; Claire Knowlton of the Nonprofit Finance Fund and Vy Nguyen of the Weingart Foundation for their assistance with survey design; and Tessa Tinkler Ph.D. of the Caster Family Center for Nonprofit and Philanthropic Research at the University of San Diego for help with survey analysis.
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The terms “overhead” and “indirect costs” are defined differently both formally and informally across the fields of accounting and management practices. However, because this paper focuses on perceptions and management of such costs – rather than accounting definitions – the terms are used interchangeably.
This was part of a larger research and education initiative of CalNonprofits called The Nonprofit Overhead Project, which also included: 1) Interviews with Los Angeles County contract managers and finance managers of nonprofits who had contracts with the County of Los Angeles; 2) Online survey of 800 randomly selected individual donors who made mid-level donations (between $200 and $1,000); and 3) Focus groups with mid-level donors in Los Angeles and San Francisco.
Despite significant technical and regulatory differences between federal contracts and federal grants, nonprofits experience them similarly and typically do not distinguish between them in discussions.
About the article
Published Online: 2017-07-21
Published in Print: 2017-09-26
Unrestricted funders whose funding makes all of CalNonprofits’ work possible include the California Wellness Foundation, the David & Lucile Packard Foundation, the Weingart Foundation, and the nearly 10,000 nonprofit members of CalNonprofits.