Are You Competing Based on Overhead—Really?

Boards should know the back-story on a ministry’s overhead.

 

by Dan Busby and John Pearson

 

Too often, boards have little understanding of
functional expense allocations and how the ministry
promotes the results of the allocations.
 

 

Picture this. As a board member, you notice that your ministry is proudly proclaiming that overhead expenses are only 12 percent. Prospective givers are told their gifts will have a greater impact—compared to their giving to other ministries.

But you wonder if that comparison is wise. So in the boardroom, you gingerly ask the CEO, “I hope you don’t think I’m in the operational weeds here, but has your team thought this through? Is our low overhead percentage really a key talking point in our fundraising story?”

At first glance, it may seem like an operational issue. However, the manner in which a ministry promotes itself is clearly a big picture issue—and big-picture issues are board issues.

Unfortunately, the giving public too often looks for one piece of data to inform them whether a ministry is worthy of their support and they have been led to believe that program expenses are good and fundraising and adminis­trative expenses are bad. Moreover, they have also come to believe that the higher the good expenses are in relation to the bad expenses, the more efficient or effective a ministry is.

We’ve often noted, “In many cases, the difference between the overhead ratios of two very similar ministries is more a function of accounting methods than operational differences.”[1] Effectiveness and efficiency are not functions of overhead allocations.

Ministries often promote their outcomes and impact—how God is using the ministry to fulfill its mission and further the Great Commission. Now that’s something to promote—but not in a comparative way.

A ministry’s overhead percentage is based on numbers on the financial statements, but it is not the type of information to be promoted. It is only information to be reported. To promote a ministry’s overhead percentage suggests a level of precision that does not exist.

Some of a ministry’s accounting information is hard data, such as cash in the bank and the mortgage balance. However, some of the largest elements of the accounting information are often soft, such as how much of compensation is allocated to overhead and how much is program expense.

Accounting rules only provide general guidelines on the allocation of expenses. The method of allocating the expenses simply must be reasonable and consistently applied. And “reasonableness” is in the eye of the ministry and its CPA firm.[2] As Michael Batts says, “Functional expense reporting is voodoo.”[3]

So what should a board know about a ministry’s overhead allocations?

  1. The overhead percentage. A board should know the overhead percentages that are reported on the annual financial statements and to the IRS, if applicable.
  2. Inclusions in overhead and program expense. A board should have a general idea of the types of expenses that are allocated to overhead vs. program.
  3. The ministry’s philosophy in allocating overhead expenses. Board members should understand how much emphasis is placed on overhead allocations. Does the CEO tell the accounting department that the goal is to report overhead of a specific percentage for the year? Or is the accounting department given the freedom to appropriately minimize overhead allocations without pressure to hit a certain target?
  4. How overhead data is communicated to the ministry’s constituents. Is the ministry measuring its performance based on subjective expense allocations? Is a low overhead number promoted as a reason why givers should support the ministry? Is the ministry’s comparative rating by outside groups, with the ratings significantly based on overhead percentages, used to compete with other ministries?

What should a board do with this overhead knowledge? A board should be familiar and comfortable with the ministry’s overall approach to handling overhead expenses. This includes the functional expense process and especially how this information is being shared with prospective givers.

 

BOARDROOM LESSON
_______________________________

Don’t be tempted to raise funds inappropriately
by touting low overhead rates.
Overhead rates are highly subjective and defy precision.
 

  Board Action Steps:

  1. Educate: Invest time in helping the board clearly understand the big picture of ministry overhead allocations.

  2. Approve: Once the board learns the basics of the ministry’s philosophy of allocating overhead expenses, affirm the principles in the Board Policies Manual.

  3. Communicate: Ensure that the board is at an appropriate comfort level when communicating overhead expense information to constituents.

 

Prayer

Lord, help our ministry communicate
our performance with clarity and integrity
using sound concepts and principles. Amen.
 

 

 

[1] Dan Busby, TRUST: The Firm Foundation for Kingdom Fruitfulness (Winchester, VA: ECFAPress, 2015), 105.

[2] “Let’s Admit It—The Emperor Is Naked: Functional Expense Reporting for Nonprofit Organizations Is Voodoo.” Posted January 6, 2013. Batts Morrison Wales & Lee: https://www.nonprofitcpa.com/lets-admit-it-the-emperor-is-naked-functional-expense-reporting-for-nonprofit-organizations-is-voodoo/.

[3] Ibid.

 

From More Lessons From the Nonprofit Boardroom: Effectiveness, Excellence, Elephants!, 2019, www.ECFA.org/KnowledgeCenter.


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

Navigation