Expenses: The Big Three
Dear Erin,
I’m sorry we didn’t connect these past few days - lots going on on both sides. Sounds like we were both doing some year-end financial work. I’m glad to hear you are staying on top of your monthly income and expenses, not to mention annual filings.
I can’t remember if we talked about this before: are you recording how much of your expenses go into each of the “Big Three” buckets?
You are still small enough that you don’t need to use the full IRS 990 for your year end compliance reporting, I think. But you are getting close… nice job growing revenue by the way! When you do have to fill out the full lengthy tax return, you are going to have to break your expenses down into three categories: Program Service Expenses, Management and General Expenses, and Fundraising Expenses. Every dollar you spend needs to go into one of these three categories.
Yes, you still have to say whether the expenses are compensation, advertising, legal, etc. (These are your “accounts” in accounting lingo.) But you also have to assign the expenses to a category. For example, you spent $1,000 at the printer for advertising. What was it for? If it was for programs that you needed printed for a show, that’s a Program Services Expense. If it was invitations for a Gala, that’s Fundraising Expenses.
Sometimes, you need to split a single expense into two or more buckets. Ideally, you’ve established a rule to help you do that based on an estimable metric. For example, our Executive Director spends 25% of his time overseeing programming curriculum, 50% meeting with donors and fundraising and 25% generally managing the team and working with the Board. Therefore, we split his salary into the three buckets according to his time spent: 25%/50%/25%. We split our website expenses evenly across the three buckets 33%/33%/34% because we use it for program registration, receiving donations and generally promoting the organization.
Don’t take the easy way out by just stuffing things into Management and General. If you rent an office, it’s tempting to put that in general and leave it be. But, if it is used for programming work or fundraising work, split it up using some reasonable allocation method. Here’s why: it’s important to properly allocate costs so that you can fully represent how much you are spending on programming and fundraising.
Programming especially is important to donors. Your supporters want to see that the majority of the funds they are providing you are supporting your programs, not management salaries or fundraising. After you get all the expenses allocated across the three buckets, you then express each as a percent of total expenses. Best practice is that your Program Services Expense is 67% or more of total expenses. Any less, and your donors are going to wonder about your overhead and efficiency. Why are you spending so much of the money they give you running the place and not serving the mission?
That’s not exactly fair…and many in the nonprofit world are triggered by these ratios. How do donors expect us to run good programs and serve the mission if we cannot invest in the costs of managing the organization? I get it with fundraising, though. If you’re spending more than 20% of total expenses on fundraising, people are going to ask why. Another way of framing the issue is to say that in this case 20 cents of every dollar is spent raising the money - suggesting expensive big donor dinners or swanky galas that cost more than they raise.
It definitely can be frustrating, as you need to do what’s right for your organization regardless. Still, the ratios do give you a bit of a North Star for how you are investing resources. And, whether you like them or not, the IRS requires that you report this way! So, the sooner you build the framework to think about your expenses as falling into these three buckets, the better!!
Love, Mom
PS this picture makes me laugh.
