As donors try to make the most impact with their year-end giving, I hear this a lot: What percentage of your expenses goes directly to the program and what goes to overhead?
 
This question is about cost allocation, the process nonprofits use to divide up their annual expenses into three categories: program, administration and fundraising (administration and fundraising together are typically referred to as overhead). Spending at least 75 percent of expenses on direct program costs is considered a best practice.
 
The results are presented in the form of a pie chart. The popularity of infographics has made this pie chart a common way to compare nonprofits. Nonprofits with higher program expenses are typically seen as a better place to donate.
 
Seems logical at first glance, I know.
 
However, savvy donors don’t use cost allocation alone as a measure of performance. Even the leaders of the top three sources of nonprofit information do not encourage it.
 
There are at least two reasons why.
 

Don’t Compare Apples To Oranges

Differences in nonprofits with unrelated missions cannot be captured in one pie chart. A nonprofit that builds houses will have a different business model and infrastructure requirements than one that collects and distributes food or provides counseling services. Even as one nonprofit grows, fixed versus variable costs will change over time.
 
Because of these differences, the laws about calculating cost allocations are vague. Each nonprofit decides how to break up expenses for their organization. Because there is no uniform way to allocate costs, the information may be misleading.
 
To be as reasonable and justifiable as possible, WARM’s cost allocation is determined by a third party CPA during our annual audit. He found that 89 to 90 percent of our expenses were direct program costs in the past two years. This is due in part to the 20,000+ volunteer hours served every year. Not every nonprofit uses volunteers to this extent.
 

Overhead Isn’t Bad

The fixation on keeping overhead low can lead to poor business decisions. Fundraising and administration are important parts of a healthy, responsibly managed nonprofit.
 
Fundraising is critical to sustainability and growth. Savvy donors invest in nonprofits that actively and ethically seek other funders so they will stand the test of time.
 
About seven years ago, WARM’s leaders focused on increasing awareness about our mission. We invested in marketing material and launched a new event, Raise the Roof Gala and Auction. That year, the fundraising piece of our pie was larger than usual.
 
But guess what?
 
The whole pie has gotten bigger!  Our efforts have resulted in higher revenue and we are now serving more than double the number of families annually.
 
Most administrative costs are not optional. Quality accounting services, appropriate insurance policies, properly trained staff, and well-equipped offices are required for legal compliance and efficient mission execution. Savvy donors want their contributions to be properly accounted for, protected and used wisely.
 
WARM is currently overhauling our information systems. In 2018, we will invest in technology that can improve our efficiency. The leaner our operations become, the more people we can help!
 

Savvy Stewardship Questions

You expect responsible financial management. These questions will give you better information than an arbitrary pie chart. Feel free to add more in the comments section below.

• How does your board measure the nonprofit’s performance?
• What are your financial management goals and values?
• Where do you see the program in five years?

 
Understanding the nonprofits you support will give even more meaning to your end-of-year giving.
 
Check out WARM’s alternative gift catalog at www.WARMfortheHolidays.org.

Combining her professional experience in the Cape Fear region’s housing and real estate for-profit sector and volunteer experience with disaster recovery and housing-related nonprofits, JC Lyle (formerly Skane) was hired in 2009 to serve as the executive director of Wilmington Area Rebuilding Ministry (WARM). WARM is a grassroots nonprofit whose mission is to make homes safer by completing urgent repairs, accessibility upgrades and storm damage. Under her leadership, WARM has steadily grown from serving 44 households in 2008 to 155 households in 2016. Her public recognition includes Wilma Magazine's 2012 Woman to Watch in the Nonprofit Category, a 2014 Coastal Entrepreneur Award in the Nonprofit Category, given by the Greater Wilmington Business Journal and UNC Wilmington’s Center for Innovation and Entrepreneurship, and invitations to speak at NC Center for Nonprofits Conference and NC Affordable Housing Conference. She will graduate in May with her Master of Business Administration at UNC-Wilmington.