Nonprofit organizations are subject to a unique accounting and reporting requirement that requires the reporting of expenses according to the purpose for which they are incurred. This process, referred to as functional expense allocation, is one of the more challenging areas of preparing a nonprofit organization’s financial statements.
As per the IRS Form 990, that applies Generally Accepted Accounting Principles (GAAP), nonprofits are required to segregate their entire costs into three expense categories:
1. Program Service expenses: These are costs related to providing the nonprofit organization’s programs or services in accordance with its defined mission. For established nonprofit organizations, program service expenses generally represent the majority of the overall expense of the organization. The public generally prefers to see a nonprofit organization with the largest allocation to this category.
2. Management & General Expenses (M&G): These are costs related to administering the day-to-day activities of the nonprofit organization. These expenses do not directly relate to the purpose for which the organization exists and typically includes activities such as bookkeeping, management, and governance. While important to the operation of the nonprofit, organizations generally try to minimize these as much as possible.
3. Fundraising expenses: These are costs of all activities that relate to an appeal for financial support or for a contribution to an organization. Examples of these expenses are the costs of holding a fundraising event, solicitation of contributions, or salary of individuals involved in the fundraising process.
Overhead costs are calculated by adding Management & General expenses with Fundraising expenses, and then dividing by total expenses. In simpler terms, a nonprofit’s overhead costs include rent, utilities, accounting, technology, administration, professional fees, and other expenses that are not tied to any one program but are vital to sustaining a healthy organization.
On an average, charities spend nearly 37 cents of every dollar on overhead. That means just 63 percent of contributions go to services that further the nonprofit’s mission. Off late, nonprofit organizations feel pressures to conform to expectations to keep overhead expenses down, and thus maximize the proportion of resources that can be devoted to programs.
Large NFP’s are redirecting 79% of all their funds to fulfillment of their mission. However, Small Non for profit organizations need to balance their spending to maximize their program dollars while providing sufficient resources to effectively run operations and raise funds.
So how do the most successful nonprofit organizations manage to keep their overhead to a minimum without sacrificing productivity?
Quatrro suggests the following two ways:
1. Internal – Through Enhancing Financial Transparency
In today’s economy, human service agencies, member and educational organizations, charities, and other nonprofits are under tremendous pressure to maintain financial transparency and accountability. Financial transparency with board and staff facilitates in reducing overhead costs by helping the stakeholders understand where and how much of a non profit’s funding is going to various aspects of their business. Adoption of best-in-breed technology equips the nonprofits with relevant and meaningful insights into budgeting, expenses and related costs.
However, non-profits often refrain from investing in technology platforms that not only allows for inefficiencies to creep in but also deviates their attention from focusing on their mission.
2. External – Through Outsourcing
Non profit leaders are not essentially against the idea of improving their technology, infrastructure and augmenting their management capacity, yet they are reluctant to actually implementthese changes because they do not want to increase their overhead spending. In such a scenario, it becomes critical for the nonprofits to partner with trusted finance and accounting providers that can provide best-in-breed technology at fractional price points and thereby enable the nonprofits to focus on their mission without worrying about the financial health of their organization.
Numerous nonprofit organizations are now turning to outsourcing to significantly reduce personnel and overhead costs. It is not uncommon for a nonprofit to save more than 20 percent of total personnel costs when they switch to an outsourced solution for accounting and payroll requirements.
To conclude, we can say that, partnering with the right firm opens up a whole new world of efficiency gains and cost-savings for a nonprofit organization.
Quatrro possess a wealth of experience in assisting not-for-profit clients to understand and implement sound financial management practices. From internal operating statements to funder reporting, from accounts payable processing to audit preparation; Quatrro offers specialized accounting services for the nonprofit sector through our Shared Service Center that translates to more efficient cash flow monitoring and reporting. With over 24 years of experience in providing accounting services to nonprofit organizations, Quatrro can handle day-to-day operations, reduce overheads and ensure timely reporting to senior management periodically.
If you are a nonprofit leader and would like advice on how to minimize your organization overheads while strengthening financial controls & accountability, please contact us