How do you allocate overhead costs?

One of the clients I'm working with has always only had one budget for the entire organization. This is fine for small nonprofits that only really have one or maybe two programs, but this client has grown out of that stage, and has at least five or six distinct programs and program areas that should be broken out of that budget.

While we were working on that, the question from staff came up of, "How do we allocate the overhead costs to each program?"

There may be many more ways to do this than I am aware of (I'm a grantwriter and management consultant, not an accountant), but the three basic ways I went over with them were Dollars, Time, and Space.

Dollars: The simplest way to do your overhead calculations is by overall dollars and percentage of the budget. In this method you break your budget down by program, including administration and fundraising as an overhead "program." If your overhead is 12% of the total programs budget (full budget, less the overhead), you simply add an overhead line item to each program of 12%.

This type of calculation is easy to do in Excel or any other accounting or spreadsheet program you may be budgeting in, and looks nice and clean. It's also handy to know what your agency's overhead rate is, in case a donor or funder wants to know.

But, it's also a bit deceptive. Do all programs draw from overhead equally? Are each of your programs really requiring the same percentage of your nonprofit's overhead? If you really want to get an idea of a program's true cost to your agency (and I'd think you'd want to), you'll probably want to look at one of the other methods.

Time: In this method, you break your budget down by programs, and make an "overhead program" as you did in the previous method, but you do not divide the overhead equally. Instead, you look at the total hours each of your employees puts into each program, then determine what percentage of total hours that program demands. If a program eats up 25% of your staff's time, then it gets 25% of the overhead budget.

This method is based on the idea that if that's where all your employee's energy is going, it's probably also where the attention of management and fundraising is going as well. And, you might be surprised that a program that's only 20% of your budget is eating up 60% of your staffing hours. This method recognizes that labor intensive programs require more overhead (management, space, supplies, etc.) than other programs.

Space: This method is similar to the time method, but instead of looking at your time sheets, you look at your square footage. Figure out the percentage of your total square footage each program uses, and use that percentage to divide out the overhead. Does one program require a massive building, while another with similar staffing require only a room with a few cubicles? Then that program should take up a larger share of the overhead.

This method is based on the idea that overhead costs are often directly related to space costs, including rent, utilities, taxes, and insurance. If you own your own building, or have donated space, this might not be as important to you.

Every organization is different, and you may want to base your overhead split on a combination of Time and Space, or some other factor that I've left out in this simple explanation. For the client in question, I suggested we go by the Time method, at least in this first time breaking out the programs from the total budget.

What other ways do you use to allocate your overhead costs? Post a comment if you're doing something different than the methods I've just described.

"Charities are more than financial statements"

PND (Philanthropy News Digest) today has an article on making the case for funding administrative costs that quotes Bennett Weiner, CEO of the Better Business Bureau Wise Giving Alliance, as saying:

Charities are more than just financial statements, and people shouldn't make donation decisions solely on financial statements.

If a charity spends 80 percent of its expenses on programs, it doesn't necessarily mean that it is doing a better job than one that is spending 70 percent.

As refreshing as it is to read that quote, it is not, however, how most donors think about overhead costs. Donors - individuals and foundations - prefer to fund programs for a number of reasons. First of all, it's far "sexier" to say your money is saving children rather than making paperwork more efficient. Additionally, according to a study by the Center for Effective Philanthropy, "It's easier to track funds allocated to program[s]."

So, how do you make the case for administrative costs funding? Eric Schwarz, CEO of Citizen Schools, Boston, says:

The key is you don't call it overhead. Talk about metrics. Show that to get even better results and expand to reach more kids we need to invest in our team.

It's hard to save the world when you're sitting in the dark without any lights or a computer or coworkers. It may not be "sexy" but it is necessary.

Bay Area nonprofits score well, Learning from SPAM, and a Happy New Year

First off, I want to thank all of my readers and subscribers for your support in 2006. This has been a great year, and I've been very pleased with the reaction to this blog since starting it a few months ago.

Second, I apologize for having taken a slightly longer than anticipated break during the holidays, but there was a bit of family business that needed my attention. All is well and good now, and I am looking forward to a great and productive 2007.

On to the news...

According to the Mercury New, most large Bay Area nonprofits spend the majority of their funds on programming. Of course, that's what we expect them to do, but in this business, we all know how administrative and fundraising costs can creep upwards.

MediaNews researched and analyzed 100 large Bay Area nonprofits and found that 85 of them reported spending at least 75 percent of their annual revenue on programs. The benchmark the study looks in "healthy" nonprofits is 75 percent or more for programming, 15 percent or less for administration, and 10 percent or less for fundraising.

The warning signs for donors (according to the survey), and the reason why some nonprofits failed to meet their guidelines, was the use of high-cost telemarketing or other outside fundraising services. Companies that collect and sell used vehicles on behalf of nonprofits were also called out for passing too little of the sales price of the vehicles on to the causes they claim to represent.

Knowing that donors are looking at these reports, and are aware of the costs of outside services, do you need to re-evaluate how you're raising money for your organization? Would you have passed the test?

While we're on the topic, "a fundraiser" of the Don't Tell the Donor blog, asks, "What can nonprofits learn from spammers?"

No, he's not suggesting that we spam our donors or potential donors. But, he does point out the sophistication of some the spammers research and techniques and asks, "Are your approaches to fundraising emails this sophisticated?"

Just some interesting food for thought as we begin a new year.