“What exactly is ‘overhead’?”

Generally, nonprofits have two types of costs: those that are directly related to its programs (what the nonprofit does in fulfilling its mission) and those which provide leadership to and support for those programs.

Examples of the former, aka ‘direct costs’, are the staff who provide the programs along with any other costs directly attributable to those programs, e.g. travel by staff, professional memberships, supplies unique to the program, etc.

Where there are multiple programs, each would have its own unique direct costs separate from those of other programs.

Examples of leadership and support costs, aka ‘indirect costs’, are the leadership of the organization along with other staff supporting programs and the rest of the organization such as accounting, payroll, purchasing, building maintenance staff or rent, fundraisers, etc. and non-personnel costs such as utilities, IT programs, office supplies, etc.

‘Overhead’ has become the conventional label for what used to be called ‘indirect costs’. (See the Note at the end of this Commentary.)

“OK. I think I understand what it is. But why is it so important?”

Overhead is important because it is needed. Organizations, profit and nonprofit, cannot function without leadership and support. Organizations are like the human body: it doesn’t work without a functioning brain and other essentials like water, oxygen, blood and nutrients and the mechanisms to process and deliver them to the entire body.

“What are the consequences of under-funded overhead?”

Chances are you already know too well the consequences of under-funded overhead: leadership unable to spend time raising badly needed funds due to pressing operational needs, outdated computers and software, inadequate office supplies, ancient furnishings and limited housekeeping and building maintenance, late and unreadable financial reports, delays in purchasing and payments to vendors, hiccups in payroll and benefits administration, ad nauseum.

Using the body analogy again, limiting the supply of water, air and other essentials and handicapping the ability to process and circulate them inevitably means the body will function below its capabilities, sometimes severely so and ultimately with fatal consequences.

But the worst costs are to those the nonprofit should be serving as well as it possibly can.

“If it’s so important, why won’t governments and institutional funders like foundations pay for overhead?”

The answer is typically some combination of these factors:

1. Both want to get the biggest possible bang for their bucks, which means – to them – funding programs and services, not overhead.
2. Funding programs and services gets them votes and admiration. There are no votes and no admiration for funding maintenance and office supplies. No one is going to brag to their colleagues, constituents and friends about supporting fundraising costs and office copiers.
3. They know from experience that it is highly unlikely that a nonprofit will refuse their money because they won’t pay for overhead costs.
4. They also know that nonprofits will knock themselves out raising other funds to cover overhead costs.

So the short but very real answer to why governments and foundations won’t pay for overhead is because they can because they don’t have to.

Note: The change from ‘indirect costs’ to ‘overhead’ is worth further discussion, and will be in a subsequent Commentary.

This commentary is copyrighted © 2015 by Ron Wormser.