Chief financial officers (CFOs), boards, and donors all want to see their not-for-profit organizations manage their financial resources well. They want as many dollars as possible put toward the programs and activities that further the organization’s mission. In other words, they want overhead and operating costs to be lower than program-related expenses. The question not-for-profits must ask is: are they setting the bar for overhead expenses too low?

Operating and overhead costs are easy targets for budget cuts in not-for-profit financial discussions because they include the costs that can more or less be directly managed, such as technology investments, and development expenses. But there is a point when overhead costs are being kept too low, and the result could be detrimental to the organization’s future growth. The perceived harm of increasing investment in non-program-related ventures could be stifling the innovation that your organization needs to extend its reach. Not-for-profit organizations that are looking at their overhead costs may want to check-in and see how their budgets are affecting organizational innovation.

The Problem with Overhead Caps

Some not-for-profit organizations may be trying to keep overhead costs to a certain percentage of their total costs. The overhead “cap” looks good to boards and potentially even to donors. Boards like to see the commitment to program-related expenses. Donors may like caps because they appear to communicate how much of their donation goes toward direct program costs.

The problem is that overhead costs are rarely that straightforward. There are several overhead and administrative costs that indirectly benefit programs and organizational missions. For example, the salaries of your employees may be considered an overhead cost, but your employees are vital to your organization’s ability to deliver your services and programs. Your CFO may not be directly delivering the not-for-profit’s services, but his or her direction provides important insight for the sustainability and growth of the organization.

Moving away from the use of overhead caps doesn’t mean that your organization is disregarding its spend. There are plenty of other financial ratios and metrics that can indicate where financial inefficiencies may be occurring. Organizations can use a full financial metric dashboard when it comes to their administrative cost and overhead investments to guide decision-making and allow more room for necessary overhead spending.

Development Activities Are Needed

Communities change over time. New not-for-profit organizations could enter the market and start competing for your organization’s donor dollars. Federal initiatives could affect the funding you receive from grants. The model for fundraising and grant-making that worked yesterday may not be the best strategic path forward for your organization. To be prepared for the future, not-for-profit organizations will have to periodically rework their fundraising approach. They will need to devote some dollars toward new development activities.

The amount that not-for-profit organizations devote to fundraising activities is highly scrutinized by boards, the public, and watchdog groups. For this reason, many not-for-profit organizations aim for a level of fundraising efficiency. They look for total costs compared to total revenue to be around 20%. Maintaining fundraising efficiency can make it difficult to invest in something new that may not immediately bring in the same level of revenue as tried-and-true fundraising approaches. Nevertheless, it’s important to keep innovating with how and to whom you are reaching out to for support.

To keep costs down for new development activities, not-for-profit management teams may want to work with their development teams to determine if there are ways to scale down a new effort and “soft launch” the approach with a smaller population. For example, instead of creating a new fundraising event for 200 people, consider targeting a list of 50. Give the soft launch of a new venture some time to gain momentum and then determine whether it’s worth the expense of growing the initiative.

Management teams should keep an open mind when it comes to ideas for new development outreach activities, but use benchmarking data to help channel new ideas into initiatives that have a higher chance of succeeding. Regularly reviewing fundraising spend and results can help indicate which types of activities need more resources and where investments need to be reduced due to poor returns.

New Tools & Technology

The quest to keep overhead low may bump up against the dollars needed for new tools and technology. Technology that allows for automation of certain work tasks, for example, may be an upfront cost with a long-term payoff. Management teams may want to review how investments in technology could improve staff productivity. A new software system, for example, may allow full-time employees more bandwidth to take on other responsibilities. The removal of certain manual tasks may also help reduce employee burnout and boost staff retention.

Finding the Balance

There are ways to bring innovation into the fold of your not-for-profit organization’s strategy without spending a fortune. Not-for-profit organizations should use the tools they have at their disposal, whether it’s existing financial metrics and ratios or looking at the time spent on certain administrative tasks to determine how and where innovation efforts may be needed.

For more information on how your organization can strike the right balance between efficiency and innovation, contact us.

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Published on November 20, 2019