If the program is the heart of a nonprofit, overhead is its backbone. Overhead is known as general and administration costs and, in some circles, it includes fundraising as well. Since the definition of overhead may vary, you should be clear on what it means. For example, in government agencies, fundraising is usually not part of overhead, while other entities consider anything besides program costs, overhead.
Overhead rate on grants –Many grantors use “overhead rates” to reimburse nonprofits for administrative costs. This rate, a percentage, is usually calculated based on prior financial numbers and negotiated with grantors. The calculations can be complicated and detailed.
To decrease this complexity, the Federal government pays nonprofits a standard 10% overhead rate on their grants. This means that after reimbursing direct costs, it adds a 10% for overhead. If direct costs are $100, the reimbursement will be $110. This setup may be fine for smaller organizations, but not for larger ones that may negotiate a higher rate. The idea is for the overhead rate to cover costs that cannot be allocated easily to a program, like an electric bill for a building that houses many programs.
This rate should be reviewed every year to make sure that indeed the overhead rate is at least equal to actual overhead costs. If the rate of 10% reflects $100,000, but the actual overhead costs are $120,000, then the organization may need to negotiate a higher rate with the grantor for the next fiscal year.
Overhead requirement on grants and gifts–Another reason overhead is important is that it must be part of every grant proposal or gift. Some nonprofits have funds restricted for certain programs only with nothing much left over for overhead, forcing many to fundraise for overhead mostly. It’s a strange situation where an organization may have money to fund research programs, but cannot pay its phone bill and other basic needs. Quite real and disconcerting situation.
To avoid this issue, nonprofits have started to require a percentage for overhead to be included in the gift or grant or they cannot accept it. I have seen a large nonprofit say no to a large gift because of this issue.
Overhead should NOT be zero –Overhead exists for a reason and if it shows as zero on financial statements or tax forms, you have a problem. It could be an accounting error in classification or not understanding what overhead is. Whether fundraising is included or not, there should be something allocated to overhead in items like insurance policies, salaries or supplies. Even if all employees are unpaid, expenses exist that cannot be specifically assigned to a certain program and are part of overhead. While it’s understandable the wish to keep overhead costs low, it’s not realistic to keep it at zero.
The first thing to think about when someone mentions overhead is to understand what it means. That is very important to make sure everyone is talking about the same thing. The overhead definition and calculation may vary among grantors and even government agencies. So, ask questions about it, don’t assume anything and don’t forget about it in proposals.
Check out the book”Nonprofit Finance: A Practical Guide- Second Edition First edition nominated for a McAdam Book Award.