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Accurate analysis: cost ratios and funding nonprofit infrastructure.

Most nonprofit executives do not sufficiently articulate to their donors and the public the need for and importance of funding organizational infrastructure, a.k.a. the combination of overhead and fundraising costs. As a result, many donors value "program" expenses as most important and valid, and too often think of infrastructure costs unnecessary or even as indulgent "overhead."

Moreover, to increase donations and grants, nonprofits often feed this mindset by touting their organization as having very low overhead and fundraising costs. This view of infrastructure costs is inaccurate, misleading and detrimental to the sector.

Donors and funders expect excellence in planning, management, and evaluation, all of which cost money. Without excellence in these areas, excellence in program delivery cannot be expected. The Nonprofit Overhead Cost Project (the Cost Study), www.coststudy.org, was conducted by Tom Pollak of the Urban Institute's Center on Nonprofits and Philanthropy, Mark Hager, formerly of the Urban Institute and currently at the University of Texas San Antonio and the co-author of this column Patrick Rooney of the Center on Philanthropy at Indiana University. The study shows that overhead and fundraising costs are basic and absolutely necessary to operating a successful organization and working toward mission. The study also found that most nonprofits currently operate within reasonable norms for both fundraising and overhead costs.

Nonprofit staff and board members must explain their costs to people outside the sector. For example, most people do not realize that Web sites, annual reports, accurate accounting and time taken to answer telephones or a donor's questions--important aspects of transparency and accountability--are all "overhead" costs, as are recruitment and training of qualified executives, convening qualified boards of directors, and other activities vital to the effectiveness and efficiency donors and funders expect. Organizations could not survive, much less operate effectively, without such basic necessities.

Nonprofits understand why donors have concerns about how their money is used; it is incumbent upon the sector to clearly outline for donors at all gift levels the importance of such costs.

The Cost Study found that nonprofits spending too little on administrative costs could be ineffective in providing services to those who need them. Over-emphasis on maintaining low overhead costs can lead to limited nonprofit effectiveness in service delivery and thus limited ability to fulfill the mission.

For example, in the Cost Study, nonprofits in the arts, community development, and human services reported:

* Their development efforts were hindered by inappropriate donor database software;

* That they had inexperienced finance staff with only rudimentary financial reporting skills; and,

* That their facilities or equipment were old or inadequate.

Such situations can cause excessive expenditures on fundraising and repairs, which can result in inefficient use of funds. On the other hand, organizations that reported having sufficient financial staff, updated software, facilities, and equipment were able to meet their goals more effectively. These fundamental differences must be emphasized to funders and donors, especially those who expect to restrict gifts and grants to provide limited or no infrastructure funds.

Despite evidence that appropriate infrastructure costs lead to more effective organizations, many factors perpetuate the myth that infrastructure funding is unnecessary. Unfortunately, by announcing that 100 percent of donations will go to programs and none will be used for overhead or fundraising costs, nonprofits themselves reinforce the inaccurate belief that this is a desirable or realistic goal for all organizations in all circumstances. In reality, these costs have to be borne by somebody.

We all need to do our part to educate our colleagues and the public. Some key points:

* Ratios don't tell the full story because they are not a true measure of effectiveness and efficiency. Determining success in nonprofits is more difficult than in for-profits. So, in search of quick, easy ways to assess nonprofit accountability and efficiency, many donors and watchdog or charity rating agencies use ratios of program to overhead costs, sometimes relying solely on that ratio. Lacking other consistent measurements for "quality," financial analysts have argued that relative spending on programs and overhead reflects "accountability" and that relatively low costs of fundraising reflect "efficiency."

While these ratios offer one way to interpret a nonprofit's financial standing, nonprofits cannot be solely "rated" on them, as these so-called performance measurements do not really address performance or effectiveness at all, nor do they detect fraud or other abuses.

* There is no "one size fits all" way to evaluate nonprofits. Donors must do more research to garner meaningful data on nonprofit effectiveness and efficiency. For example, donors can review nonprofits' Web sites for more in-depth indications of the impact of their work, read their annual reports, ask who serves on their boards and what reputable organizations fund them, and talk with other donors about their experiences.

And, of course, academic and other researchers continue to try to create and hone better measures to help nonprofits be more transparent and accountable. A good starting point for nonprofits is to measure what they are doing and compare it to historical trends. Comparisons also might be made with peer nonprofits across the country doing similar work.

* Inconsistencies in completing IRS Form 990 and other reporting make ratios unreliable and not comparable. Nonprofit finances are much more complex than cost ratios would suggest, and there are no nationally consistent norms for reporting costs. Most ratios are based on self-reported data from Form 990, which, the Cost Study and other research have found, are often rife with inaccurate and inconsistent accounting and reporting, meaning one cannot accurately compare the 990 of one organization to that of another.

For example, one organization may count staff time as overhead costs, while another might count it in program costs. Some nonprofits may not count staff time spent on proposal writing or event planning as fundraising costs when they should.

* Fundraising costs vary based upon the age and type of organization. For example, younger organizations tend to have higher fundraising costs because they have to build donor lists and contacts. Similarly, organizations dealing with controversial issues may have higher fundraising costs because it may take more requests to raise the same amount of funds.

* Emphasis on ratios causes nonprofits to skew reporting and spending. Expectations of low overhead cause nonprofits to feel pressured to report low costs. Such expectations also cause organizations to spend less or to report spending less on governance, planning, compliance and risk management, data collection, evaluation and capacity building, which can be detrimental to the organization's performance and longevity. Sometimes nonprofits compete for donor and funder attention by "advertising" low overhead and fundraising costs. This is a problem, because the numbers may not be accurate, creating unrealistic expectations for funders regarding infrastructure needs.

Some leaders have begun to speak out about nonprofit infrastructure funding needs. In a 2002 paper, "Reconciling Strategic Philanthropy with General Operating Support," Paul Brest, president of the William and Flora Hewlett Foundation in Menlo Park, Calif, emphasized that any funding plan must meet the needs of both the funder and the nonprofit organization, rather than simply focusing on "overhead" versus "program" funding.

Brest suggested four general ways of approaching this issue. First, funders should work with nonprofits for input and expertise when formulating their strategies. Second, Brest suggested that funders should aim to fund overhead or general operating support when at all possible. This means ensuring alignment but tolerating some mismatch between the foundation's strategic goals and the organization's operations.

The funder may choose to support "negotiated general operating" costs. There are many forms of this, but its general aim is for the funder to find an organization whose goals match its goals, and who will engage in a process that includes setting goals, outcomes, plans for meeting them and evaluation processes. In turn, the foundation funds the organization's overall operations.

Third, the funder should seek buy-in from nonprofits in the field on strategic goals. Finally, Brest wrote that when funders specifically support programs, they should include an organization's indirect costs in the funding, because these costs must be covered by someone in order for the project or program to be successful. The main point is that there are many ways to hold nonprofits accountable for use of funds, for delivering on promises, without restricting gifts and grants.

In a recent Boston Globe column this past Feb. 27, "Saving the Best for Philanthropy," Ken Lewis, chairman and CEO of Bank of America, discussed the notion that corporate philanthropy must be flexible.

"Funding flexibility is critical because it enables a nonprofit to deploy funds that will best serve their clients and build their organization for the future. Too often, business donors restrict use of funds, inhibiting nonprofit leaders' strategic planning for long-term growth and sustainability. While nonprofits have a responsibility to help businesses understand their goals and report on their progress, businesses need to select trustworthy community partners, and then trust those partners to use funds wisely," he wrote.

As a society, we accept the axiom that "it takes money to make money." However, we need to extend this same thinking to the nonprofit sector and acknowledge that "it takes money to raise money." Moreover, it takes money to operate, plan, and budget for an effective nonprofit. Without infrastructure funding, a nonprofit cannot perform planning, management and evaluation procedures necessary to provide excellent programs.

This is not to say that nonprofits should not strive to reduce infrastructure costs, but rather to acknowledge that these costs are a necessary part of the formula for successful and effective nonprofits--just like investment in plants, equipment, research and development are necessary in the for-profit sector--and to emphasize the need for nonprofits to better educate the public and their constituents about why these costs are necessary.

Eugene R. Tempel, Ph.D., is executive director and Patrick M. Rooney, Ph.D., is director of research for the Center on Philanthropy at Indiana University.

Staffing Configurations of Independent Foundations

Foundations administer grants and programs through the efforts of a mix of people, including paid staff; consultants; representatives from banks and law and investment firms; compensated and uncompensated trustee; and other volunteers. Only about one-quarter (2,350) of the independent foundations in the study reported having paid staff in 2001. This leaves nearly three-quarters that operated through the efforts of trustees and volunteers.

The majority of unstaffed independent foundations (4,745) operate without paying compensation to anyone. Of the 8,876 independent foundations in the study, 743 (8.4 percent) compensated institutional and/or individual trustees rather than paying staff to operate the foundation.

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Article Details
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Title Annotation:Management
Author:Rooney, Patrick M.
Publication:The Non-profit Times
Geographic Code:1USA
Date:Apr 1, 2006
Words:1743
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