What Is My Functional Expense Allocation Saying About My Nonprofit?
Your allocation needs context
Your functional expense allocation tells the story of what your nonprofit accomplished during the year. However, it is a good idea to provide as much context as possible.
You may have never thought of your functional expense allocation as a story. But that is what essentially is. It tells your nonprofit’s story, highlights your greatest achievements in the year, states where each dollar went, and communicates how you administered it all. Your functional expense allocation tells the story of how each single dollar was spent.
However, even though you may be proud of your allocation, and the story it tells, it is unfortunately open to interpretation. Let’s dive and explore what these interpretations may be.
When Program Expenses are Greater
Having your program expenses be greater than the other functions may result in your financial statement users concluding that your nonprofit is not afraid to spend money into what matters most: its mission. You are willing to get your feet wet, you are not afraid to get your hands dirty, and you cannot wait to make an impact in your community. It tells the story of a nonprofit that is willing to give it all in order to serve. When program expenses are greater, contributors feel that mission delivery is your top priority. Your leadership is also very involved with the day-to-day operations. There is simply no time to spend on overhead or management.
You may be tempted to spend more resources this way because it is perceived as an altruistic act to give it all to those you serve. After all, this is why your nonprofit is in business. However, allocating more resources to program services may give the impression that your internal processes may start deteriorating sooner than later. This could result because there is a perception that because everybody is focused on furthering the mission, no time is spent (nor is it available) on finding the right people, closing the month, or communicating to your stakeholders via marketing. There may not be enough resources available to perform the annual audit or staying compliant with rules, laws, and regulations governing your nonprofit’s space. Consequently, having a significant amount allocated to program services may communicate you are more interested in serving people, but not interested in long-term sustainability or growth for your nonprofit. There may also be a hidden concern with your financial statement users that finance, HR, audit, and other G&A costs are being hidden in program. In other words, program expenses have been inflated due to optics.
When General and Administrative Expenses are Greater
You may know about the nonprofit whose executive director has to do the books because there is not enough resources left for general and administrative to hire a bookkeeper. Maybe he or she is doing all the hiring and even writing all the grants because everybody else is focused in programs. Clearly, the executive director should not be doing that kind of work. Not because it is lowly but because he or she needs to be the person in charge of transferring the vision, the person thinking about strategy, risk assessment, and other factors that significantly influence the nonprofit’s impact. These have nothing to do with the nonprofit’s mission, but are so essential to the survival and sustainability of the nonprofit that ignoring is a risk to the nonprofit. This is what happens when nonprofits are more concerned with allocating everything to program and not enough to general and administrative.
If your nonprofit allocated more dollars in the top range of recommended percentages to general and administrative, you are conveying to stakeholders that processes and internal controls are very important to you. You are spending time to make sure all financial and management reports are prepared on time, you are communicating directly and consistently to your stakeholders, and you are caring about compliance. This signals strong governance, effective administration of the nonprofit’s resources, and influential leadership.
High general and administrative expenses may bring criticism and even bad reviews from charity watchdogs. In the past, charity watchdogs would measure the nonprofit’s efficiency by analyzing its general and administrative and fundraising expenses and comparing them to total program expenses. A ratio of less than 35% spent in G&A and fundraising combined meant the nonprofit efficiently administered its resources. This is changing according to Charity Navigator when they updated their methodology back in 2023. What nonprofits should be doing is educating their donors and stakeholders on what metrics should be used to measure the nonprofit’s impact. Relying solely on G&A and fundraising ratios ignores other metrics that better tell the story of what the nonprofit has been doing recently.
When Fundraising Expenses are Greater
When fundraising expenses are greater in your functional expense allocation, users of the allocation may have the idea that your nonprofit is a startup, that it is intentional on growing, and getting funding. Why is this so? Because fundraising is essentially marketing for a nonprofit. Nonprofits with high fundraising expenses are not afraid to spend money to seek further growth via donor education, events, and other means to solicit contributions. After all, a nonprofit cannot grow if there is no revenue.
Financial statement users will look at your total contributions and see if your growth strategy is working or if its reasonable. They will see in your statement of activities the trend of contribution growth and whether new donors have been obtained. For this reason, it is a good idea to provide further metrics to let users know if the growth strategy is working. Metrics like fundraising costs per contribution dollar received are excellent to communicate how well the nonprofit is doing in this regard.
What to Do in Any of the Cases Above?
Your functional expense allocation is open to interpretation. For this reason, you should make it your priority to provide the following to your stakeholders and financial statement users:
Provide context: Because functional expense allocations can be seen positively or negatively, it is of the utmost importance to provide context and a narrative of what happened in the year, the reasons why a certain function is at the current level, and other metrics that help explain the whole picture of your organization’s operations.
Transparency is better than optics: You may be tempted to try to get your functional allocation to match to donors’ expectations or to your board’s suggestions. You may even match the allocation to what charity watchdogs suggest is a good allocation. However, it is better to be transparent and tell the truth of what happened in the year. Stakeholders will appreciate more the transparency than perfect ratios and allocations.
Disclose how you allocate your expenses: What will bring more clarity and understanding to your stakeholders, donors, and financial statement users is how you allocate your expenses. Disclose as much as you can of the methodology you use. In addition, be consistent in how you allocate year to year. Do not change methods of allocation from one year to the next just to match targets or ratios.
Your functional expense allocation does more than satisfy a reporting requirement—it communicates how your nonprofit operates, what it values, and how it pursues its mission. When paired with transparency, consistency, and thoughtful narrative, it becomes a powerful tool for telling your organization’s story accurately and credibly.
Functional expense reporting is more than a compliance exercise—it is a strategic communication tool. If you would like guidance on allocation methodology, financial statement presentation, or nonprofit audit and tax considerations, ZSO is ready to help your organization strengthen its reporting and mission impact.
