Monday, July 8, 2013

It's Time to Retire the Term "Overhead" when Talking about Non-Program Expenses

Accounting rules for nonprofits require expenses to be classified between three functional categories: program (those relating directly to the mission), fundraising (those aimed at raising funds), and administrative (those that pertain to the general operations of the organization).  Donors and watchdogs have found it helpful to examine the program expense ratio, the percentage of expenses that are program expenses, in evaluating charities' financial effectiveness.  Alternatively, one can view the ratio of non-program expenses as a measure of ineffectiveness.  It is now common to call this an "overhead" percentage.

There are, of course, many concerns that arise from excessively fixating on this number (as covered repeatedly in this blog).  In this post, though, I want to discuss something much more esoteric -- the use of the term overhead to describe non-program expenses.  This is the common jargon, one I too have adopted on several occasions since everyone in the sector knows what overhead refers to.  However, that's the problem.  I am not convinced they do.

Many have complained about the use of the overhead ratio as being destructive, since it discourages charities from incurring important costs.  In fact, the hatred of accounting has centered around this notion of overhead -- charities cannot incur advertising costs since they are overhead; charities cannot hire important staff since their salary is overhead; etc.  The push back against overhead has led to the recent "Overhead Myth" project (launched by BBB, Guidestar, and Charity Navigator) and even spawned shirts you can buy proudly declaring yourself overhead! (You're welcome for the sales uptick, Dan Pallotta.)

Here's the issue.  Technically, the term overhead in accounting refers to "indirect" costs, not "non-program" costs. Direct costs are those that can directly be attributed to a particular category, and are, thus, easy to assign.  Indirect costs (overhead) are those that do not naturally assign themselves to categories, so must be allocated.  You may say this is petty semantics, but my concern is that people assume overhead and non-program costs are the same, and they are not.  Many people who proudly declare "I am overhead" do not realize that, yes, they are overhead, but much of their (overhead) salary is allocated to program expenses.  And many of those lamenting the inability to advertise because it is "overhead" do not realize that much of advertising overhead is actually allocated to programs.

In short, perhaps it is time to start using a different term when referring to non-program costs rather than using the term overhead.  James Ulvog has suggested the term "supporting services".  It is more descriptive and less ominous to a non-accountant.  Even "non-program" would be an improvement.  Sure, it's a minor change, but baby steps toward clearing up misconceptions are steps nonetheless.

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