A charity’s overhead costs are their administrative and fundraising costs. It is relatively common to use the proportion of a charity’s budget that’s spent on non-overhead costs (often called “program costs”) as an indicator for how good (or cost-effective) the charity is. For example, this a key criterion used in Charity Navigator’s ratings.[1]
Some use overhead costs as a proxy for effectiveness on the following rationale: What we really care about is how much a charity helps others; it‘s the charity‘s program costs, not its administrative and fundraising costs, which help others; therefore the greater the proportion of its income a charity spends on others, relative to itself, the better.
The above rationale is misguided, however, for two reasons. First, overhead ratio doesn’t measure how much the charity actually helps others. For example, a charity could be spending all its money on program costs, but if the aim of the charity is to give donuts to police officers, it still won’t do much good.
Second, having a low overhead ratio may be actively bad for a charity. Charity fundraising often gets a very good rate of return, so putting money into fundraising may allow a charity to grow faster and in the long term spend more on its programs. Administration costs often include monitoring and evaluation to find out whether a program is working, and how it could be done better.
Further reading
Karnofsky, Holden (2009a) Pitfalls of the overhead ratio?, The GiveWell Blog, May 21 (updated 17 August 2011).
Karnofsky, Holden (2009b) The worst way to pick a charity, The GiveWell Blog, December 1 (updated 19 December 2012).
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Charity Navigator (2016) Financial efficiency performance metrics, in ‘How do we rate charities’ financial health?’, Charity Navigator, June 1.
Fwiw, there’s some psychological research on “overhead bias” or “overhead aversion”—donors’ tendency to focus on overhead when deciding where to donate—and how to overcome it; e.g. this Science paper and this paper by Lucius Caviola et al. Depending on how you conceive of this article, you could mention that.
You could also mention that overhead bias has two kinds of negative effects. First, it directly reduces the effectiveness of donations, since it means that donors chose a criterion that doesn’t track cost-effectiveness well. Second, it incentivises charities to reduce spending on overhead, which in turn may decrease their effectiveness (cf. The Nonprofit Starvation Cycle).
I’m a bit unsure what Charity Navigator’s current stance on overhead is. I think that they gradually may have changed their views (see, e.g. this article, and this one on their acquisition of Impact Matters). It could be good to look into that further. And potentially it would be good to have a newer reference than from 2016.
I tried to link to this page, but think I just linked to the page in the wrong way in the way that you edit tags/wikis (this is the first time I’ve done it!). Not sure why the link has just been replaced with a reference to 2016.
I only skimmed the page, but looks to me like overheads is still a key part. High “Program Expense Percentage” is good, high “Administrative Expense Percentage” and “Fundraising Expense Percentage” are bad.