Accounting and Bookkeeping

How Nonprofits Can Better Manage Overhead Expenses

Note: Articles published before January 1, 2017 may be out of date. We are in the process of updating this content.

Author: 

Managing a nonprofit organization’s overhead (management and general) expenses is just as important as managing program and fundraising expenses. Most nonprofits would not dispute this statement. However, most organizations tend to put an inordinate focus on managing program and fundraising expenses and ignore or not give equal attention to managing overhead expenses.

There are only three expense categories required to be summarized on nonprofit financial statements (statement of activities and functional statement of expenses) under United States generally accepted accounting principles (GAAP): program, fundraising, and management and general. These categories also appear on the statement of functional expenses on page 10, Part IX, of the Form 990.
If managing overhead expenses was no big deal, this category would not be included in the “big 3” expense categories on the two most important financial reporting mechanisms, GAAP financial statements and the Form 990.

To correct this imbalance, we need to draw attention to, and take a more active role in, managing overhead expenses. Using these three approaches will help your organization gain momentum for more active management of overhead.

First, schedule regular financial acumen training for management and staff covering the basic concepts related to overhead expenses to improve their understanding and heighten awareness. Start with a general explanation of direct vs. indirect (shared) costs and explain how some, but not all, shared costs are applied (recorded) as overhead expenses. A shared cost that benefits the organization as a whole (occupancy, insurance, internet services, etc.) are applied to overhead. A shared cost that benefits two or more specific programs (for example, event cancellation insurance covering two events, the spring gala and the fall annual meeting), can be split-allocated to both programs as direct costs.

Next, segment overhead expenses into three component parts; occupancy, labor, and other overhead expenses. This approach will enhance understanding of overhead and isolate shorter-term controllable costs (labor and other) from longer-term static costs (occupancy). Here the focus is on the short-term controllable aspects of overhead expense that can be managed and promptly changed when necessary.

Conclude by establishing specific performance goals for overhead expenses. This will spark nonprofits to better manage overhead expenses by both raising awareness and providing a call to action when performance shifts or erodes. Performance goals work best for situations that can be actively managed and adjusted to changing conditions, such as a delay in the start of a new program, cancellation of an event, or an unexpected increase in information technology (IT) costs, all of which could force additional costs into overhead expenses.

Planning Tip – To improve administration and performance of your nonprofit organization’s overhead expenses, assign management and performance reporting responsibilities to a specific department, management team, or individual. Make sure to include overhead performance in financial reporting, both internally to the senior management team and externally to the Board and general public. Regular oversight reporting that includes descriptions of changing trends will bring overhead expenses into a proper light and stimulate active management discussions. 

These approaches will be helpful in many ways. One of the main benefits comes from making staff more aware and better able to recognize how changing conditions and slipping compliance (bad habits) directly impact performance related to overhead expenses. For example, staff members are often reluctant to put in the additional effort and documentation to assign shared costs to direct program expenses. This is especially true for indirect labor allocations. Rising indirect labor in overhead expenses is usually an indication that detailed contemporaneous timekeeping habits are eroding. Highlighting the importance of managing overhead expenses will help to address these bad habits.

These approaches will also encourage active management of overhead costs that are hard to control in the short term, such as occupancy. Recognizing changing occupancy needs and conditions will impact planning to meet future occupancy requirements. These efforts may not change current overhead expenses but will directly impact future overhead budgets.

Overhead expenses are often considered a “fait accompli” by nonprofit organizations and thus ignored. Overhead expenses are controllable if actively managed. Moreover, rising overhead expenses are a problem that can be managed and corrected. The bigger problem is being caught off guard and not having a plan of action.