Starting today, you might choose to change the way you’ve been answering that question.
Your answer to the question is typically taken from the statement of functional expenses, which breaks down expenses by three categories – program, management/general, and fundraising. If all expenses of your nonprofit organization are necessary and reasonable, and all are required for your agency to provide its services and serve its clients, then the way you split expenses on the statement of functional expenses should be irrelevant to funders.
Among charity watchdog organizations, the Better Business Bureau says at least 65% of expenses should be for programs; Charity Navigator says the most efficient charities spend 75%+ on programs; and the American Institute of Philanthropy says at least 75% is ideal. Our experience is that the standard most often quoted by foundations is 75%.
But, the traditional split of expenses between program, management/general, and fundraising is close to meaningless because there is little consistency between nonprofits in how they record these expenses.
A study reported in Functional Expense Reporting for Nonprofits, The Accounting Profession’s Next Scandal?, by Kennard Wing, Teresa Gordon, Mark Hager, Thomas Pollak, and Patrick Rooney, published in 2006, found that:
- 37% of nonprofits with at least $50,000 in contributions report zero fundraising costs.
- One-fourth of nonprofits reporting $1 million to $5 million in contributions report zero fundraising costs, as do nearly one-fifth of those reporting more than $5 million in contributions.
- 13% of nonprofits report zero management and general expenses.
- 7% charged all accounting fees to programs, and another 20% split them across more than one category—despite the fact that Form 990 instructions use accounting fees as an example of what is meant by management and general expenses.
There are no nationally consistent norms or enforced standards for allocating expenses between the three categories. Most ratios (program expenses as a percentage of total expenses) are based on self-reported data and rationales from the Form 990, which, the above study and other research have found, are often rife with inaccurate and inconsistent accounting and reporting, meaning one cannot accurately compare the 990 of one organization to that of another.
We have found that many of our clients, for example, split the executive director’s salary between functional categories after a brief thought process as follows – 75% program, 15% management/general, and 10% fundraising. Often, expenses are functionally allocated by inexperienced people, maybe even the executive director’s next door neighbor’s cousin who’s just trying to help out, and the results are used on the 990 and even make their way to audited financials. And yet funders look at the results of that thought process, the reporting of amounts by functional category, as though they’re meaningful – as though reported program expenses of 76.3% for one organization is really better than the 72.8% reported by another organization. They say the organization reporting 76.3% is more “efficient.”
Actual costs vary between nonprofit agencies based on many factors other the “efficiency” of the organization. One organization may record staff time as administrative costs, while another might record it as program costs. Some nonprofits may not record certain staff time, such as time spent on grant writing or event planning, as fundraising costs, though most others do. Fundraising costs can vary based upon the age and type of the organization. Newer organizations tend to have higher fundraising costs because they have to build donor lists and contacts. Organizations dealing with controversial issues, such as AIDS, often have higher fundraising costs because it may require more effort to raise the same amount of funds as other nonprofits do with less effort. Organizations that provide services to abused or sick children generally have the easiest time raising funds, and often the lowest fundraising costs. But that doesn’t mean they’re doing a better job on fundraising than organizations with a less popular mission.
Some funders take issue if a high percentage of a nonprofit’s total expenses is for salaries. But salaries as a percentage of total expenses vary greatly between nonprofit organizations depending on an agency’s mission. One client of ours provides wishes for children dying of cancer (not Make-A-Wish Foundation), and only 20% of total expenses are for salaries because most of their expenses are for outside organizations providing the wishes. Many nonprofits have 50-75% of total expenses as salaries because most of their services are provided by staff and not vendors. One of our clients has a private school for severely developmentally disabled children and they have a 1:2 teacher/student ratio. Does that mean they’re less “efficient” than a school for “normal” kids with a 1:15 teacher/student ratio, or less deserving of donations?
Much of the amount paid to vendors for services and supplies is paid by those vendors for salaries in their own business, but funders never question those salaries. Is it better to pay vendor’s salaries than staff salaries?
We hope you finish reading this blog with two take-aways:
1. Ideally, when a prospective funder asks “What percentage of your organization’s expenses is spent for programs?, your answer should be “100%.” If that answer isn’t appropriate under the circumstances, a good answer might be:
“100% of our expenses are necessary for us to provide our programs. We don’t make any expenditures that are not required for us to be able to operate our organization. In order to comply with IRS requirements (and Financial Accounting Standards Board requirements if your organization has audited financials), on the Statement of Functional Expenses we report X percent (insert the percentage from your most recent Statement of Functional Expenses) of expenses as direct program expenses.”
2. If you are not currently recording at least 75% of your organization’s expenses as program expenses, change it today. As discussed above, there is no consistency between nonprofit organizations in allocating expenses between program and other, and many other organizations very similar to yours are reporting a far higher percentage of expenses as program than yours does. You should be very aggressive in deciding how to allocate expenses – not inaccurate or deceptive, but aggressive.
Recent grants received by our clients include:
$711,000 (over 3 years) for an organization that provides real-world values-based business skills to inmates so that once they are back in society they have the tools, skills and support structure to pursue healthy, fulfilling and productive lives - for workforce training