U.S. charities that file the full IRS Form 990 report their expenses in Part IX, the Statement of Functional Expenses, which sorts them into three columns: program services, management and general, and fundraising. The overhead ratio is the share that falls in the second and third columns. A charity that spends $100 with $15 on management and fundraising has an overhead ratio of 15 percent.
Why it became the default
It is printed on a public form, and it seems to answer the question donors most want answered: how much of my gift reaches the cause? Part IX does not itself measure results.
What it can’t tell you
The ratio says how costs are split, not what they buy. Some costs of running an organization well land in those columns, while shared costs must be allocated by function under the IRS instructions, and they are often what make a program work. A charity can spend almost nothing on overhead and achieve nothing, and another can invest heavily in systems and change thousands of lives.
The ratio also shapes behavior. Ann Goggins Gregory and Don Howard described a nonprofit starvation cycle: funders expect low overhead, charities feel pressure to meet the expectation, so they underspend on infrastructure and underreport what they do spend, which keeps expectations low. They cited a study in which more than a third of organizations reported no fundraising costs at all, and a 2001 survey by the Better Business Bureau in which more than half of American adults said overhead should be 20 percent or less.
An open letter
In June 2013 the leaders of GuideStar, Charity Navigator and the BBB Wise Giving Alliance, three organizations that donors turn to for information about charities, published an open letter calling the overhead percentage a poor measure of a charity’s performance. They asked donors to look instead at transparency, governance, leadership and results. They also said that very high overhead can still be a sign of fraud or poor management, so the ratio can prompt further questions without being a verdict on its own.
What could replace it
Finding a simple public measure that tracks results without being easy to game is Open Problem 6, the Overhead Replacement. The raw material exists: Charity Impact Media publishes Form 990 spending breakdowns, with every number linked to its filing and no ratings attached. See also the Myth-Busting Series on the claim that a low overhead ratio means a good charity.