Impact or Investment? How to View Cost Ratios

Whether you’re just getting started in direct-response fundraising or have a robust multichannel program to engage donors, all nonprofits are faced with the challenge of balancing funds raised and how they’re used against operating costs.

You’ve heard of charities receiving bad press due to their overhead costs. You also know that without spending money on fundraising, your ability to effect change will remain stagnant, or worse, shrink. How do you find a good balance?

This week, Seth Godin, marketing extraordinaire, wrote a blog post about this very subject. He encourages readers not to balk at steep salaries of some top nonprofit executives. Godin says, “Everywhere else in our lives, we happily invest in the best solution to our problem … If a problem is worth solving, it’s worth engaging with the right people to solve it with urgency, isn’t it?”

And there’s good news. Charities have long been ranked and rewarded based on how little they spend, not on impact. But that thinking has changed. Competition has grown for donors and dollars, forcing a shift in the way charities do business and how they’re evaluated.

One of the long-held performance benchmarks — the fundraising cost ratio — is losing favor as the sole indicator of a charity’s efficacy and efficiency. Fundraising cost ratios, while helpful, are imperfect. Circumstances, practices, and investments vary widely between organizations and across the nonprofit sector. But even when ratios are used — for example, during review of grant requests — they are no longer viewed as the lone measure, nor predictive of, a nonprofit’s performance.

Many charities have recognized the limitations of cost ratios. By investing more in fundraising, they are now generating recurring, reliable revenue for long-term growth. This isn’t despite an increase in their fundraising costs — but because of the additional investment. These results, in turn, assure donors and funders that their dollars are being spent wisely.

Cost Ratios: The Wrong View and the Long View

There is mounting industry-wide evidence that emphasizing cost ratios as a measure of a charity’s performance is the wrong view. Here are four top reasons:

1. Variability in Circumstances and Sources
   According to Association of Fundraising Professionals (AFP) position paper, “Measuring and Reporting Fundraising Costs: Guidelines for Board Members,” where funding comes from can dramatically impact cost ratios. AFP recommends the following: “Consider increasing your organization’s overall investment in fundraising. If spending more for development costs allowed your organization to develop its capacity to generate more net revenue, it could be a wise decision in the long run — even if the cost per dollar raised increases.”
2. A Focus on Mission
   Focusing on mission performance and not on overhead as a measure of success has had a groundswell of support across the industry — so much so that a campaign called The Overhead Myth was created to end the belief that financial ratios are so indicators of nonprofit performance. This is so important. The very organizations that initiated the focus on ratios are now seeking to undo it!
3. Ratings Have Changed
   The shifting focus on how nonprofits are measured compelled top watchdog group Charity Navigator to change its ratings system in 2016 from solely focusing on amount spent on programs and overhead to factoring in results.
4. The Long-Term View of Fundraising
   The entire reason nonprofits exist is to change lives and impact the world in a positive way. Measuring success and efficacy based on results makes much more sense than the simplistic accounting view cost ratios provide. To do this, a long-term view of fundraising is a must.

How a Direct Fundraising Program Can Impact Cost Ratios

The goal of any organization is to have a diverse fundraising portfolio that encompasses everything from major gifts, planned giving, and events, to individual giving, corporate giving, and direct mail. In order to employ this kind of successful multichannel approach, charities should consider ratios useful as part of their larger plan — which should include investing dollars into acquiring and cultivating donors who will provide reliable revenue for years.

One of the best ways to acquire and cultivate individual donors is through a direct marketing program. This helps you build a pool of committed givers and provides you with recurring, reliable income for long-term growth.

What’s more, results show that an investment in a direct marketing program impacts cost ratios more favorably over time. As your charity’s fundraising program begins generating significant net revenue, you’ll have much more money to spend on programs, which tips the scale of program versus overhead favorably.

When an investment in fundraising yields a high return, it’s important to focus on what that return will impact in the future: more lives redeemed, patients healed, families fed, veterans honored, and animals defended.