If a charity spends less than half its funds on its programs, does that mean it's ineffective?

Advice on how to make the world better.
Sept. 9 2009 12:52 PM

The 50-Cent Rule

If a charity spends less than half its funds on its programs, does that mean it's ineffective?

Do you have a real-life do-gooding dilemma? Please send it to ask.my.goodness@gmail.com and Sandy will try to answer it.

Illustration by Robert Neubecker. Click image to expand.

Dear Sandy,

I've heard that when donating, you should look at a charity's finances in order to find out how much of your donated dollar goes to fixing the problem rather than just administrative costs. My wife told me that if less than 50 cents per dollar goes to program costs, you shouldn't donate. Is that the right percentage? How can I find that information? Will this research really help me make better donations?

—Karl

Sandy:

You've stepped into one of the most vigorous debates in philanthropy. The nonprofit community has been grappling with these questions for years: What constitutes "administrative costs"? How much is too much? Can we—and should we—stop donors from being so obsessed with them?

Often used interchangeably with "overhead costs," "administrative costs" refer to all funds that go to the overall management of the organization. Rent, electricity, legal counsel, insurance, office management, HR, and so on. IRS instructions for filling out the Form 990 (the 501(c)3's equivalent of a 1040) explain that in addition, "overall management usually includes the salaries and expenses of the organization's chief executive officer and his or her staff" as well as "costs of board of directors meetings; committee meetings, and staff meetings (unless they involve specific program services or fundraising activities) ... and management of investments." Or pretty much everything besides mission-related, on-the-ground service-delivery and advocacy. Fundraising costs are separate and merit their own line on the 990 but are often included when people talk about overhead costs.

Now that you know what administrative costs are, where can you find them? The IRS makes all 990s publicly available, and both the Foundation Center and GuideStar have PDF copies searchable on their Web sites. Other sites, such as Charity Navigator, post information from the 990 but not the document itself. Reading a 990 is fairly simple, but the Foundation Center's tutorial may be a helpful introduction to the form. To calculate the percentage of each donation going to programmatic work, just divide the "program services" total (Line 13) by the "total expenses" (Line 17).

While 50 percent of funds going to administrative costs seems awfully high (Charity Navigator says the national median is 10 percent, and 76 percent of charities ranked on its site used less than 30 percent of their total budgets for administrative costs), it'spossible that there are organizations doing great work with that ratio. It's harder, for example, to raise funds for a highly contentious issue than something such as relief services after a tsunami. And more man-hours and mailings to attract funding would lead to a higher administrative-expense ratio. As Paul Brest, president of the William and Flora Hewlett Foundation, said, "the ideal of every organization and those who support it is not to minimize, but to optimize all costs, including administrative costs." So pay enough attention to the finances to make sure that most of the money is going to programs (I would say that less than 70 percent should make you look closer), but don't give much weight to hard-and-fast rules that demand every charity meet a certain threshold.

Also beware that even if the percentage going to overhead seems fabulously low, it might not be for the right reason. A 2004 study by the Urban Institute's Center of Nonprofits and Philanthropy and the Center on Philanthropy at Indiana University found that more than one-third of organizations reported no fundraising costs, and one in eight reported no management and general expenses on their 990 forms. When they did a closer review, they found that 75 percent to 85 percent of the organizations reported the number incorrectly.

Before you go sleuthing, you should know that lots of people would tell you not to bother. Looking at a charity's financial information is great, helpful even, but it doesn't give you the full picture. You wouldn't base a financial investment solely on a company's overhead, would you? So why use it as a proxy for a charity's efficacy? The forms tell you nothing about whether an organization is meeting its objectives. Or whether its objectives were good in the first place. And they certainly don't tell you anything about how Charity A accomplishes its mission in relation to Charity B. So use the financial information for what it is worth—an easy indicator of an organization's financial health and expenditures—but don't let it alone determine how you donate.

Do you have a real-life do-gooding dilemma? Please send it to ask.my.goodness@gmail.com and Sandy will try to answer it.

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