Fiscal Fitness - A newsletter about issues in the nonprofit business world
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A newsletter about issues in the nonprofit business world
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Editor's Note
Do you know what your organization's true overhead rate is?
If you aren't 100% sure, it's probably higher than you think.
So how do you find out? And more importantly, how do you
reduce it? In this issue, Fiscal Fitness regular Thomas
McLaughlin covers all the details involved in calculating —
and lowering — your true overhead rate. As always, if you
have any comments or questions, please contact us at
[email protected].
July 2005 Contents
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Editor's Note
Doing the Math: Finding
Your True Overhead Rate
5 Tips to Help Reduce Your
Overhead...Today
Latest and Greatest
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P.S. If you're interested in complex accounting issues, check out the session, “What’s Really Going
on Here? Creative Analyses of Complex Accounting Issues,” (presented by this month's author) at
the 2005 Conference on Philanthropy.
Doing the Math: Finding Your True Overhead Rate
By Thomas A. McLaughlin
Raise your hands if you like spending money on overhead. Go
ahead, hold them up high … there’s one hand. (Sir, this is the nonprofit
session — the seminar on Defense Department contracting is next door.)
Okay, now raise your hands if your overall overhead spending rate is 10
percent or less. How many are at 20 percent or less? Where are the 30
percent or less people?
There are no surprises here. Nonprofits have some pretty low overhead rates. That’s good.
Everyone is diligent about keeping the overhead rate low.
There’s only one problem with the responses: you’re not looking at your true overhead rate. And if
you aren’t looking at your true overhead rate, you’ll feel: a) smug, and b) trapped by your
apparent accomplishment when it comes time to cut costs.
To understand the situation, let’s analyze the way you carry out your programs and
services. Do this in the privacy of your own office before venturing out into the world with it.
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Fiscal Fitness - A newsletter about issues in the nonprofit business world
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What you’re looking for is the core of your spending on mission-related services. Start with a dollar
of revenue for your organization. Of that dollar, a large percentage probably goes toward
personnel costs such as wages, salaries, benefits, and payroll taxes. The calculation looks like this:
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A dollar of average nonprofit revenue: $1.00 x Percentage used for personnel = 70 percent:
$0.70
Those 70 cents represent all the money that goes toward the organization’s personnel. But you
know that in every nonprofit only a portion of those dollars go toward the people providing
services directly related to the mission. These are the people called direct service workers, or a
term to that effect. What portion of the total amount spent on personnel they represent will vary
from organization to organization, but let’s say a reasonable amount would be 60 percent. (Don’t
cheat here. Include no managers, administrators, financial staff, or anything of the kind — just the
people in the trenches here.) Here’s the next step:
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A dollar of average nonprofit revenue: $1.00
Percentage used for personnel = 70 percent: $0.70
60 percent of personnel dollars in direct service: $0.42
The 70-cent mark is reduced considerably now, as you zero in on only the dollars used to support
mission-related activity. But you can’t stop here. Even the funds supporting direct service aren’t
fully utilized. People working in these positions get sick and take holidays and vacations. They also
spend time on administrative duties, work on things not directly related to mission (collateral time,
it’s called), and, well, goof off, just like everyone else.
How does one calculate this non-direct time? In a different context this would be called lack
of productivity, and the fact is no individual can be productive 100 percent of the time. Service
firms, nonprofit and for-profit, which get paid only when staff members are delivering direct
service (such as psychologists or visiting nurses), pay a great deal of attention to levels of
productivity.
To translate that attention into the terms of this example, you need a productivity rate, or the
percentage of time that direct service folks spend on average actually providing direct service.
Let’s assume that these mythical direct service personnel are expected to be productive 70 percent
of the time after deducting vacation, sick, collateral, and wasted time. This may actually be a high
number, because vacation, sick, and holiday time alone usually accounts for around 12 to 15
percent of a year’s worth of time off, and the remaining 15 to 18 percent doesn’t leave much time
for anything other than a solid work effort with a small margin for error and waste.
Still, give the hypothetical example the benefit of the doubt and assume a high productivity rate.
The new calculation is:
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A dollar of average nonprofit revenue: $1.00
Percentage used for personnel = 70 percent: $0.70
60 percent of personnel dollars in direct service: $0.42
Assume 70 percent of above is actual service: $0.29
Now do the final math, multiplying 0.42 by 0.70. This gives a final result of 0.29, meaning that
every $1 of revenue buys $0.29 worth of direct service.
Here’s the punch line: if 29 cents is the amount of direct services produced, then 71 cents is the
true overhead rate.
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It’s helpful to go through this exercise because most nonprofits proudly emphasize their low
overhead rates, and with good reason. On the books, many, if not most, nonprofits don’t spend
much on overhead. To check your publicly reported spending, go to the second page of your IRS
Form 990, add the totals of the columns at the top labeled “management” and “fundraising,” and
divide the total by the total expenses in the column to the left.
There are twin problems with this approach, however. The first problem is that most
nonprofits are sensitive to a public reporting of management and administrative costs, and they
take pains to keep those numbers as low as possible. When cuts need to be made, many
managers’ first instinct is to look to administrative costs, reasoning that that’s where the most
painless cuts can be made without affecting the ability to deliver mission-related services.
If you proudly proclaim your management and general costs to be only, say, 10 percent of overall
spending, you’ve drawn a pretty small bull’s eye for cost reduction. It will be that much harder to
hit, and it probably won’t be realistic to expect it to produce significant savings.
Worse, narrowly defining overhead in the traditional way strangles creativity and broader ways of
thinking about costs. After all, what’s in the 71 percent is everything that doesn’t directly relate to
the mission, and it is therefore a candidate for being cut or reduced.
In looking for unnecessary costs, details count. For example, suppose an organization
required all direct service staff members to fill out a form each week and to transport it by hand to
a specific location. If it took the average person 40 minutes to fill out the form and another 20
minutes to walk it to the right people and then return, they would be using one hour each week
for non-mission related things.
Now imagine that the information on that form never got used for anything. Perhaps the person
who put it together left the organization without explaining how to derive data from the forms, or
it’s been so long that no one really remembers why the data was felt to be needed in the first
place. The only reason it’s filled out is because it’s always been filled out. The form creates
widespread non-productive time.
Throw out that form and every direct service person gains one hour of time. Doesn’t sound like
much, but remember that one hour represents 1/40th of a person’s standard work week. That’s a
2 percent gain in productivity. Put another way, saving 40 people one hour is like getting the
equivalent of one staff person for free. Put yet another way, if you can prevent that one staff
person form being needed in the first place, it could mean approximately 2 percent more salary
dollars that could be distributed to all direct service staff.
Overhead spending is a drag on the economics of any organization, as streetsmart managers
know. Controlling it requires dedication and an unyielding determination to use dollars for what’s
truly important. To control it means you have to know where to find your true overhead costs.
About the Author
Thomas A. McLaughlin is a national nonprofit management consultant with Grant Thornton in
Boston. He is the author of Streetsmart Financial Basics for Nonprofit Managers and the
forthcoming book The Art of Strategic Positioning: Decide Where to Be, Plan What to Do (John
Wiley and Sons, late 2005). His email address is [email protected].
Meet the author at this year's Conference on Philanthropy
Meet Thomas McLaughlin and attend his sessions “An Introduction to Nonprofit Mergers and
Alliances” and “What’s Really Going on Here? Creative Analyses of Complex Accounting Issues” at
Destination: Success — Blackbaud’s 2005 Conference on Philanthropy.
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5 Steps to Help Reduce Your Overhead...Today
Are you in over your head due to rising overhead? Try these costcutters to reduce overhead without having a negative impact on morale or
productivity.
1. Analyze workflow and internal processes to eliminate wasted
action and schedule efficient use of personnel.
2. Buy supplies in bulk. Contracts for supplies are negotiable,
3.
4.
5.
especially if you have high volume and the vendor wants your
business. You also may find purchasing success through an affiliation with other nonprofit
organizations.
Work the phones to your advantage. Competition among phone service providers can
be a boon for organizations looking to cut costs. Ask your current provider and their
competitors to analyze your existing call patterns and volume and ask them to give you a
better service package.
Use secondhand furniture; a new desk isn't going to make your organization raise more
money. There are many good, used desks and chairs on the market at prices sometimes
half (or lower) than that of new stock. For the best deals, scan the newspaper, call the local
chamber of commerce, or visit a furniture liquidator or used furniture store.
Automate administrative tasks and processes in order to reduce the number of
employees required to do a certain job, or provide the capability for existing staff to handle
more. Here are a few examples of areas with automation potential:
{ Billing and collection
{ Data entry processes
{ Registration applications
{ Order entry, purchasing, and accounts payable processes, as well as the paper flow
activities between your organization and its vendors, have significant savings
opportunities by automating much of the process
Latest and Greatest
Nonprofit Resources
Download the latest white paper: Accountability Matters
This complimentary white paper on nonprofit accountability discusses the critical issues facing
nonprofits today, including real-life examples of what can go wrong and what you can do to
establish accountability at your own organization. Download the white paper here. (PDF 170K)
Upcoming Events
Destination: Success — Blackbaud's 2005 Conference on Philanthropy
This year's Conference is from October 23-26 in beautiful Charleston, SC. Register before July
29 and save up to $300! Visit conference.Blackbaud.com/cfo to learn about our financial
management track and sessions we've created just for readers like you!
Upcoming Web Seminars
Attend a complimentary Web Seminar on The Financial Edge™ (for non-Blackbaud
clients)
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Fiscal Fitness - A newsletter about issues in the nonprofit business world
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