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WHY ARE NONPROFITS NOT IN PROFITS?

Updated: Jun 13, 2022



Introduction

The amount spent by any organisation on indirect expenses directly varies with the success of the organisation. This is not news, and nonprofits are no exception to the rule. Yet most nonprofits do not incur enough indirect expenses or do not spend enough money on overhead.


Researchers found out that these organisations frequently agree with the idea of improving infrastructure and building up management capacity, yet they are reluctant to increase their overhead spending. Various findings suggest that underfunding of overheads can have disastrous effects - non functioning computers, incompetent staff, etc can effect the beneficiaries at large.


The question arises why the non profits still continue to cut back on overhead if this can jeopardise the very existence of the organisation and their ability to fulfil their missions?


Research reveals that a vicious cycle fuels the continuous underfunding of overhead. A vicious cycle which is leaving nonprofits so hungry for decent infrastructure that they can barely function as organisations - let alone serve their beneficiaries.


The cycle starts with funders’ unrealistic expectations about how much it costs to run a nonprofit organisation. At the second step, nonprofits respond by spending too little on overhead, and by under-reporting their expenditures. This underspending and underreporting further motivates funders’ unrealistic expectations. Overtime, funders’ expect grantees to do more and more with less and less - a cycle that slowly starves the nonprofits.


Funder’s Unrealistic Expectations

It is not very easy to determine that from where the cycle really starts. However, the most useful place to start analyzing this cycle is with funders’ unrealistic expectations. Neither is it easy for the nonprofits to address the cycle and report its true overhead cost to the funders. Because, in the economic times like these, it could be catastrophic for the organisation, especially if no other organisation follows suit. They can also end up losing major funding.


Resetting funders’ expectations would help pave the way for honest discussions with the organisations.


Many funders’ know that nonprofits report artificially low overhead figures, and without accurate data funders’ do not know what overhead rates should be. In the absence of a clear, accurate date, funders’ trust the reported numbers. As a result, funders’ routinely require nonprofits to spend unhealthily small amounts on overheads.


Studies show that foundations are quite variable in their indirect cost allowances, with the average ranging from 10 percent to 15 percent of each grant. Many times, the funding doesn't even cover the cost of administering the grants themselves.


Other surveys also find the individual donors’ expectations to be skewed. According to them, the majority felt that the overhead rates of nonprofits should be 20% or less. Infact, those surveys ranked overhead ratio and financial transparency to be more important features in determining the willingness to fund an organisation than its success.


Not only do funders’ but nonprofits themselves promote unhealthy overhead levels. Even when they know that with their dishonest fundraising literature, they are fueling unrealistic expectations, they still somehow find it difficult to justify spendings on infrastructure.


For example, an organisation claimed that 100% of its donation will go towards the program and zero percent goes towards overheads. This is not because they have no overhead; rather, it is because it takes support from its founding members for its non program cost.


This constellation of causes further puts pressure on nonprofits to obey the unrealistic expectations which brings us to the second stage in the cycle: Underfed overhead.


Underfed Overhead

All of us have seen how the organisations who are unable to pay competitive salaries for qualified specialists, end up hiring employees who lack necessary experience or expertise. Similar is the case with nonprofits, underfed overhead forces them to limit their investment in staff, which makes it difficult to develop a strong pipeline of senior leaders.

Findings prove that CEOs of such organisations usually agree that to run an organisation, the most important capital is human capital.

Also, without strong tracking systems, it becomes difficult to analyze which actions truly drive their desired outcomes. But, the funders’ expect a strong program outcome before even investing in these general operating support. Even the staff becomes accustomed to their strained circumstances at a certain point of time that they face troubles in justifying the much needed support.


Misleading Reporting

The final driver of the cycle is the nonprofits’ routine misrepresentation of how much they actually spend on overhead. Research shows that more than 30% organisations show no fundraising costs whatsoever, while one in eight reported no management and general expenses. Further examinations find out that 4 out of 5 surveyed organisations were incorrectly reporting their costs.


Many other factors support this underreporting of nonprofit costs. Accountants also suggest the nonprofits to misrepresent the costs, for tax benefits. Organisations also tend to report marketing and communication expenses to programs, when in most cases these should be reported as administrative or fundraising overheads.


Proper Care and Feeding

Since, there is not a single entry point to this vicious cycle and all the 3 reasons drive it, the suitable place to end it is where it starts: Funders’ unrealistic expectations. The power with funders’ and the government make them responsible to take the lead. Changed expectations of granters will make the grantees feel less in need to underreport their overhead and will also be empowered to invest in infrastructure.


The priority should be the outcome and not the cost. The questions asked by funders’ need to shift from costs to Measure of Success(MOS) and motive of the organisation. This will help the organisations realise that nothing matters more than the impact generated.


Funders’ must also clearly talk about their goals with the organisations. With the alignment of goals the questions like “what will it take to deliver these outcomes? “ can be asked from the organisations.


Funders’ should also help the organisations meet identified infrastructure needs by making general operating support grants. Studies find that both the organisations and the funders’ agree on the importance of a good infrastructure in improving the results qualitatively as well as quantitatively.


Regardless of the support, there should be an open flow of communication between both the parties regarding goals, requirements, etc.


Although changing their expectations will have the greatest impact on the cycle, there are other ways as well in which the funders can intervene. They should commit a greater share for administrative and fundraising costs.


Likewise, rather than laying down an indirect expense rate for all grants, nonprofits should be allowed to define their true overhead needs in grants applications, and if justifiable, funders should pay for them.


Finally, there needs to be a standard definition for the term overhead. It will allow the organisations to better understand their own overhead investments or lack thereof. It will also help to shift the focus to the real target: outcomes.


What Organisations Can Do?

The organisations are equally responsible for breaking the nonprofit starvation cycle. The leaders of nonprofit organisations should be committed to understand their real overhead costs and their real infrastructure needs.

They must then speak the truth and real numbers to the funders with the help of their board. Case studies show that a shared agenda between the leadership body, board and funders has helped in success of those organisations.


Board members should also ask the real questions like “Where are we underinvesting?” and “what are the risks we are taking by underinvesting?” Board members should help theleaders understand the infrastructure needs and develop the plans for the same. During their discussion, focus should be on how the investment in infrastructure can actually benefit the beneficiaries and reduce the cost in the long run.


Finally, Donors need to be educated and they should be explained other expenses apart from program costs



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