Few topics generate more confusion — and more harm — in philanthropy than overhead. The persistent belief that good nonprofits spend very little on administration, and that funders should restrict grants to "direct programme costs," has been thoroughly debunked by research. Yet the overhead myth persists, driving a systematic underinvestment in the organisational capacity that makes effective work possible.
The overhead myth holds that administrative expenses — management, human resources, finance, communications, IT, fundraising — are wasteful, and that the best nonprofits minimise these costs. On this view, 100% programme expenditure is the ideal; every dollar "diverted" to administration is a dollar not helping beneficiaries.
This view is wrong. Here's why:
Overhead enables programme delivery: Staff management, financial systems, facilities, and technology are not separate from programmes — they are the infrastructure that makes programmes possible. A health clinic cannot serve patients without administrative staff booking appointments, managing clinical records, billing, and handling HR. Cutting administration doesn't eliminate these functions; it just means they're done badly.
Underinvestment creates dysfunction: Nonprofits chronically underfunded for administration become dysfunctional organisations. Staff burn out when management support is inadequate. Financial controls fail when finance capacity is thin. Programmes collapse when IT systems are inadequate. The apparent savings from low overhead hide substantial performance costs.
Overhead ratios are easy to game: Clever accountants can reduce apparent overhead by reclassifying programme and administrative activities. Overhead ratios measure accounting decisions as much as organisational efficiency. They are a poor proxy for programme quality.
Context determines reasonable overhead: A small community organisation with minimal infrastructure might legitimately have 10% overhead. A research institution with sophisticated lab facilities and compliance requirements might legitimately have 40% overhead. Neither figure indicates efficiency or inefficiency without knowing what the organisation does.
Full cost grantmaking recognises that every programme has indirect costs — the management, financial, and administrative work that supports it — and that these costs should be funded, not shifted elsewhere.
Direct costs: Staff time directly delivering the programme; materials and supplies; programme-specific facilities.
Indirect costs (overhead): Management and supervision; finance and compliance; human resources; technology; communications; fundraising; rent and facilities shared across programmes.
When funders restrict grants to direct costs, they force grantees to:
- Cross-subsidise from unrestricted income (if available)
- Reduce administrative capacity below functional levels
- Misclassify administrative costs as programme costs
- Decline grants that would cost more to administer than they cover
None of these outcomes benefit grantees or their communities.
US Federal government: The US Office of Management and Budget allows nonprofits to claim negotiated indirect cost rates — typically 20-40% of direct costs — on federal grants. This is an explicit recognition that indirect costs are legitimate and fundable.
UK practice: Many UK government grant programmes and major foundations now explicitly fund indirect costs, often at 20-30% of direct costs.
Australian context: Australian government contracts often specify indirect cost contributions; philanthropic practice is evolving but many major foundations now include overhead allowances.
New Zealand: Government contracting practice varies; some ministries include overhead components, others do not. Philanthropic practice is improving but overhead resistance persists.
Include indirect costs in grants: Calculate grants to include a reasonable contribution to indirect costs — typically 15-30% of direct programme costs. Many funders specify a flat indirect cost rate for simplicity.
Provide unrestricted core funding: Core grants — unrestricted or largely unrestricted — allow organisations to deploy funds where they are most needed, including to underfunded administrative functions. Core grants are among the most valuable forms of philanthropic support.
Ask about organisational health, not overhead ratio: Instead of asking "what proportion goes to administration?", ask about staff retention, financial reserves, board governance, and system quality. These are better indicators of organisational health than overhead ratios.
Fund organisational development: Explicit grants for capacity building — finance system upgrades, IT investments, HR support, governance development — recognise that organisational infrastructure is legitimate and valuable.
Stop using overhead as a metric: Remove overhead ratio from grant application forms and assessment criteria. This signals to grantees that you understand that overhead is not waste.
Publish your indirect cost policy: Many grant applicants don't know whether funders will cover indirect costs and are reluctant to ask. Publishing your indirect cost policy removes this uncertainty.
How do we know grantees aren't padding their overhead?
Review the budget carefully — not the overhead percentage, but the line items. Is the staffing appropriate for the programme? Are facilities costs reasonable? Are system costs justified? Detailed budget review is better accountability than overhead ratio limits.
What if all our grantees use their overhead allowances for different things?
This is fine. Different organisations have different underfunded needs. A grantee might use overhead funding for a new finance system; another for professional development; another for fundraising capacity. The variety reflects diverse organisational circumstances, not misuse.
Should we fund fundraising costs?
Fundraising is an essential organisational function. Organisations that cannot fund their fundraising capacity become wholly dependent on any single funder — including you. Funding reasonable fundraising costs is in your interest as a funder.
What about very small grants?
Small grants (under $5,000) may not warrant complex indirect cost negotiations. But even small grants should cover their administration — if a $2,000 grant costs the grantee $500 to administer, the net value is $1,500. Factor this in.
The real question in grantmaking is not "how much goes to overhead?" but "is this organisation capable of delivering what it proposes?" Organisational capability depends on having adequate management, systems, and infrastructure. Funders who understand this invest in full-cost grantmaking and reap the benefits of better-functioning, more effective grantees.
Tahua's grants management platform helps foundations manage full-cost grantmaking — with the budget tracking, indirect cost allocation, and portfolio reporting tools that make covering the full costs of effective programmes simple and accountable.