Although still important to donors, the expense ratio (what a charity spends on administrative, overhead and fundraising costs vs. program costs) is now sharing the spotlight with other measurements as a way to judge an organization's effectiveness.
The traditional appeal of expense ratios is obvious. They are easy to calculate using data from financial statements or Form 990s and provide a standard metric with which to compare all not-for-profits. Watchdog groups vary somewhat in the expense ratios they advocate, but most agree that "effective" not-for-profits spend at least 65% to 75% of their budgets on program costs.
Many in the not-for-profit community question the benefit of expense rations. Clearly, they do not tell the whole story. In addition, because watchdog groups, donors, foundations and government regulators have placed such a strong emphasis on this single metric, many not-for-profits felt pressure to under-track and under-report actual administrative and fundraising spending. Some not-for-profits have even neglected to make the organizational infrastructure investments that are essential to continued health and future growth. Ironically, pinching pennies to improve the appearance of fiscal responsibility can undermine an organization's long-term effectiveness.
Some influential groups have begun to shift their emphasis on expense ratios to other areas. The Charities Review Council, for example, revised its Use of Funds (essentially, an expense ratio) standard to reflect that no one range is ideal for every charity and to encourage more infrastructure investment. Other groups such as Charity Navigator, GuideStar and GiveWell do not believe that expense ratios or executive salaries provide meaningful data to determine a not-for-profit's impact and utilize other data to rate not-for-profits.
Many not-for-profit professionals have advocated placing less emphasis on "outputs" — such as the percentage of funds spent on programs — in favor of "outcomes" — a program's measurable impact in the community. Not-for-profits need to craft a clear and compelling message to illustrate financial performance. A good starting point is to develop a method of measuring your success appropriate to your mission. Track these results and explain them clearly in the "Summary" section on your Form 990 and in fundraising and marketing materials. Be proactive in telling your story. Not only are real-life examples of program outcomes compelling, but the reporting of the results — not just dollars spent and activities conducted — strengthens an organization's position for fundraising and public trust over time.
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