Faced with limitations on direct and indirect cost recovery, funding nonprofit overhead can be challenging for nonprofits.
Three Functional Categories
The importance of tracking functional expenses for nonprofit organizations.
There are three categories of functional expenses:
- program services
- management and general
Tracking expenses using these categories gives nonprofit management vital information to measure if programs they operate are sustainable with resources available from revenue generated. But, the true price tag of operating your programs is not just direct program expenses, but a portion of management and general and fundraising expenses needed to run and fund those programs. These additional expenditures are commonly referred to as indirect costs.
What are Overhead Expenses
- Direct Costs: Actual expenses required to operate the program, including salaries, payroll taxes, rent, utilities, supplies, and any other expenses that are specific to only that program.
- Indirect Costs: Include items associated with running the organization as a whole, including administrative staff salaries, rent, utilities, office supplies, etc. Your entire organization uses these expenses both for administrative purposes and for other programs.
- Overhead Costs Allocation: When calculating the total outlay of running your programs, it is common to allocate a portion of your administration and fundraising expenses to programs using an indirect cost rate.
The combination of both direct and indirect spending is taken into account when preparing your budget, especially when considering a grant application. Unfortunately, some funding sources limit their support to direct program expenses. This creates a problem for nonprofit management who must provide adequate revenue to cover their expenses in order to fulfill their mission. If indirect spending is not covered, the organization as a whole may be worse off because they cannot cover all their obligations.
Impact of Overhead Funding
Faced with limitations on direct and indirect cost recovery from funding sources, nonprofits struggle with a number concerns in this area. While indirect costs are necessary expenses toward the management and viability of the organization, many funding sources look at these disbursements as overhead and do not want their funds dedicated to overhead expenses.
If the funds provided were without donor designations and nonprofits could use the funds in the best way to fulfill their mission, then these issues would not exist. But most funding sources limit their support to direct program costs, and do not consider expenses necessary for the organization to exist and do work which constitutes direct costs.
Overcoming Overhead Challenges
To overcome this problem, nonprofits must get funding sources to understand — based on their business structure and operations — these indirect costs are essential to execute their mission and serve their constituents. Determining the rate of allocating these indirect costs to programs is critical to securing the necessary funding for both overhead and program costs. Having a clear and concise allocation rate of indirect costs to programs will significantly increase the chances of getting funds approved from funding sources.
Funding sources will apply a great deal of scrutiny in analyzing direct expenses of a grant application. If there is ample evidence proving without indirect costs assigned to the program, the program will not achieve its goals, then there will be a better chance of getting their grant approved.
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