The “Overhead Myth” is a common misconception that nonprofits with the lowest Overhead Ratio are perceived as the most effective. However, it’s important to debunk this myth and gain a proper understanding of overhead costs, as all organizations have them.


What is the Overhead Ratio?

The Overhead Ratio refers to the percentage of support services to total expenses. Support services encompass management and fundraising, and membership development costs. Overhead is also referred to as administrative costs, fixed costs, or indirect costs. However, the Overhead Ratio does not indicate the true impact of a nonprofit. A lack of overhead can limit a nonprofit’s ability to deliver its mission, communicate the true cost of services, and growth.


Three reasons why the Overhead Ratio is a poor indicator of effectiveness:

  1. It is a misleading measure of performance.
  2. It fails to consider important investments nonprofits need to make.
  3. It disregards transparency, governance, leadership, and results.

There are two significant principles that assist management in framing the overhead conversation with donors, funders, and the public: cost allocation and revenue diversification.


Cost Allocation and Revenue Diversification

Cost allocation is the process of spreading shared expenses across programs and support services. Common methods include allocating salaries and benefits using estimates of time and effort or allocating facility costs based on square footage.

Best practices for cost allocation:

  1. Allocate according to a written cost policy.
  2. Clearly define which costs have been allocated and the methods used.
  3. Ensure that methods are reasonable and consistently applied.

Revenue diversification is an excellent strategy to help fund overhead costs. However, it’s advisable to speak with a tax professional to consider any tax implications.


Opportunities for revenue diversification may include:

  1. Earning fees from consulting or training services.
  2. Renting out unused space.
  3. Applying for government funding opportunities.


Managing overhead is complex, but YPTC can assist clients in wading through cost allocation and implementing best practices.

For more on this topic, download Understanding Overhead: So It’s Not Over Your Head, on demand now.