The statement of activities for not-for-profit organizations (NFPs), known as an “income statement” in for-profit entities, categorizes expenses into three main functional categories:
- Program services: expenses directly related to carrying out the organization’s mission,
- Fundraising: expenses to raise funds and support for the organization, and
- General and administrative (G&A): expenses related to the overall management of the organization, such as legal and accounting fees.
For example, if an organization’s mission is hunger relief, the cost of purchasing food and the salaries and benefits of the personnel who distribute it would be classified as program service expenses. Marketing materials, as well as the salaries and benefits of staff who recruit volunteers or solicit donations of food or money, are considered fundraising expenses. The salaries and benefits of employees and fees of consultants who administer bill payments, oversee IT infrastructure, and manage payroll and benefits are deemed general and administrative expenses.
NFPs, and those who evaluate their financial results, often strive for program expenses to comprise 75% or more of total expenses, with combined fundraising and G&A expenses (commonly referred to as “overhead”, “indirect expenses”, or “supporting services”) accounting for 25% or less of total expenses. This is sometimes described as the number of cents from each donated dollar that go directly toward serving beneficiaries.
While these targets serve as useful guidelines, organizations sometimes focus too heavily on meeting these percentages. For example, it is not unusual to encounter situations in which a client’s accounting department is woefully understaffed, yet the board of directors refuses to allow additional hiring to keep overhead low.
Of course, most organizations wish to allocate as many resources as possible to achieve their charitable objectives. No one wants to feel that funds are wasted on bloated overhead or bureaucratic red tape. However, it is crucial to recognize that supporting services form the foundation of the entity. Without a strong foundation, the entire organization is at risk of failure.
It is also important to understand that certain phases in an organization’s life cycle may naturally lead to a higher overhead percentage, such as its initial launch or during a major restructuring.
Proper fiduciary oversight means ensuring that accounting, human resources, IT, and other overhead functions are appropriately staffed. Neglecting these areas can result in weak internal controls, cybersecurity vulnerabilities, fraud or other malfeasance, reputational harm, high employee turnover, loss of revenue, and, ultimately, diminished capacity to fulfill the organization’s mission. Although excessive overhead is undesirable, insufficient supporting service capacity to effectively and efficiently meet the organization’s needs and safeguard assets can be extremely damaging.
Some organizations may be tempted to classify expenses too aggressively as program services to reduce their reported overhead ratio. This can weaken the integrity of the financial statements, trigger audit adjustments, and raise concerns with key stakeholders, including auditors, grantors, and the board. Functional expense targets should serve as guidelines, not rigid rules. Management’s foremost responsibility is to ensure the charity is appropriately staffed to achieve its mission and that its fiscal responsibilities are handled with integrity.
Next Steps
If you have questions regarding proper expense classification or the appropriate staffing of supporting service functions, please consult your outsourced accounting team, auditors, or other consultants.
CBIZ provides a comprehensive suite of services to help not-for-profit organizations strengthen operations and advance their mission rom outsourced accounting and IT to HR support, benefits and insurance, compensation studies, and operational assessments. To discuss how our team can support your organization, connect with a CBIZ professional today.
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