Q: Are overhead ratios the perfect measure of NPO efficiency and effectiveness?

A: No way.

This is the conclusion of Saundra Schimmelpfennig in her e-book, Lies, White Lies, and Accounting Practices; Why nonprofit overhead doesn’t mean what you think it means

Many people believe that the ratio of supporting services to total expenses is the ideal way to measure the efficiency of a nonprofit organization.

Even at a conceptual level, that is a flawed idea.

At a practical level, Ms. Schimmelpfennig explains it is so easy to play games with the functional allocation that the overhead ratios should be viewed skeptically.

She explains just a few of the games an organization can play.

I’ve been auditing NPO’s for over two decades. For all that time I have known that the functional allocation is the most judgment-laden and difficult area to test during an audit.

Let’s just say I’ve been aware for a long time of the games she describes.  She actually introduced me to a few new issues.  (Must admit I hadn’t thought of outsourcing some of your administrative functions to a partner NPO and calling the payments a program expense.)

Astute auditors know to look for these issues, know to watch for the biases that throw off estimates, and will challenge allocations that are unreasonable. Less astute auditors, not so much.

Back to the conceptual level.  

She makes the absolutely correct observation that efficiency is not the same as effectiveness.  Many people donate to an organization because of the low overhead ratio assuming that percentage has some correlation with effectiveness.  

Even if the overhead ratios are done reasonably well, efficiency and effectiveness are two completely different things.  An organization can be wasting their effort and have wonderful overhead ratios. Or, an organization can be changing the world every hour of the day but have “bad” ratios.

Her conclusion:

Nonprofit overheads are almost meaningless. It is time to stop perpetuating the myth that the administration ratio is any indicator of a nonprofit’s efficiency or effectiveness. Overheads are no indication of the impact or quality of a nonprofit’s work nor does it show whether what they are doing is actually helping.

The book is available at Smashwords here, or at her blog here.

Ms. Schimmelpfennig is using the name-your-own-price option. You can pay what you think the book is worth, with options of zero or $0.99 on up.  I’d suggest something in the “on up” range.

Since you can name your own price, it might be worth buying a bunch of copies and send one to each of your board members. 

Or all your major donors.

Or maybe include a copy with every grant proposal you send out.

Ever read a book and say “wish I’d written that”?  That was my reaction. Only I would not have kept it to 5,400 words.

Check out this book for a brief introduction to the issues surrounding overhead ratios.  It’ll be worth a few minutes and a few bucks.