In an historic letter released today, GuideStar, Charity Navigator, and the BBB Wise Giving Alliance have joined forces to caution against overemphasis of the overhead ratio when judging a nonprofit’s quality or worthiness as a grantee.

The use of overhead ratios to judge nonprofits has probably intensified in recent years as information on nonprofit budgets has become increasingly accessible through organizations like these. One or two of them may even have encouraged that  emphasis. But the use of overhead as a primary proxy has always been intensely flawed and has brought unfortunate consequences. Organizations have starved themselves of necessary infrastructure in a misguided attempt to fit a single formula. What’s worse, many nonprofits feel that they have to fudge their numbers to fit, which means obfuscating the real information about how much it costs to serve a variety of organizational needs across size, stage of development and field. This is valuable information for comparative purposes, and it’s being obscured.

Recently, for instance, Forbes ran a series of articles about the practice of “daisy chaining” contributions of in-kind goods among some organizations doing international aid. One organization transfers medication or other goods it has received to another, counting the transfer as a program cost without having to actually deliver the material. The same goods may travel through multiple nonprofits and NGOs before being delivered to an end user. The practice makes each organization look bigger than it is so that its overhead looks smaller, with the aim of making each participating organization more attractive to donors.

Obviously, this is an extreme example, but you get our point. The use of this as a measurement, in and of itself, has caused some habits that are not particularly healthy or productive.

Need we say that the idea that you can judge an organization’s worth on how much it spends in certain categories is a bit silly? Clara Miller is fond of making the comparison to a hotel. Imagine that you went traveling and refused to take a room until you were informed about how much the inn spent on administration. Even if you were given that information, would you then compare that ratio to that of, say, your local airline?

NPQ has published a good deal on this topic, including some recent articles that promoted the continued use of the overhead ratio, though perhaps with more balance. But their message to donors regarding how donors evaluate charities for support also applies to major institutional funders, such as foundations and governmental agencies. Their practices in grantmaking can reinforce the shading some nonprofits do of their overhead expenditures. Historically, many foundations made it their policy to refuse to include nonprofits’ overhead calculations in their grant awards. The logical result is that nonprofits either squeeze out overhead expenditures or hide their administrative costs as part of programmatic expenditures.

The same signal sometimes occurs in disaster relief. Although disaster relief efforts have trended toward more openness about administrative costs, many disaster relief operations both small and large have come to promise donors that 100 percent of their donations will go to the victims or to services, with no administrative or other overhead costs. Sometimes, to hide the overhead, the coordinating agencies will do separate fundraising for administrative costs, but the result sends a signal to donors that contradicts the message of Guidestar, Navigator, and the Wise Giving Alliance.

On the governmental side, any nonprofit that has struggled with the overhead standards in OMB circulars at the federal level or the requirements at the state government levels knows how frequently nonprofits end up underfunded for their administrative costs on government grants and contracts. Here, too, nonprofit vendors find themselves in the awkward circumstance of delivering services that not only don’t pay for themselves, but also starve the agencies of necessary administrative infrastructure investment.

The cogent message of the three sponsors of the overhead myths letter will have a powerful effect on donors, but it should also be absorbed by the other opinion-setters in the industry—foundations and governmental agencies. If, either through regulation or simply through practice, foundations and governments choose to use overhead as an isolated one-size-fits-all measure of grantworthiness, or they pursue grant or contracting practices that diminish or eliminate administrative funding, the strategy they’ll be pursuing will weaken the nonprofit sector.

Guidestar, Navigator, and the Wise Giving Alliance help shape opinions in the nonprofit sector through the ratings that two of them issue and the overall analyses generated by all three. It is critically important that this letter is seen and interpreted as a clarion call to donors to look for more robust, more revealing measures of nonprofit quality. The next step would be for their overhead myths letter to be incorporated into the grantmaking behavior of institutional grantmakers, whose decisions shape aspects of public policy toward nonprofits.

—The editors of Nonprofit Quarterly