Paying what it takes approach to grantmaking – report launch 2022

Indirect costs in Australia

Indirect costs (or overheads) are a fraught topic in the not-for-profit (NFP) world. Many people across philanthropy, government, the public and the media expect them to be minimised, or not to pay for them at all. Yet they are essential to running a functioning, effective organisation.

In the context of a struggling NFP sector, this is a crucial issue to ensure the long-term effectiveness of Australia’s charities. US research has shown that one of the key drivers of NFP vulnerability is insufficient funding of charity indirect costs. This is called the “non-profit starvation cycle”, in which funders having inaccurate expectations of how much overhead is needed to run a not-for-profit means that charities under report their costs to funders. This leads to a sector starved of the necessary core funding required to create resilient charities delivering long-term impact on complex social issues.

Our research

Three organisations (Centre for Social Impact, Social Ventures Australia, and Philanthropy Australia) worked together to understand the extent of this issue in Australia, and start to unpack what could be done.

Our research uncovered four key points:

1. Indirect costs are not a good way to assess charities – NFPs that spend less on indirect costs are not necessarily more effective than those who do not. Indeed, there is clear evidence that spending insufficient resources on indirect costs can potentially reduce overall NFP effectiveness.
2. Charities’ true indirect costs are not being covered by funders – on average, the true indirect costs of each charity were 33% of their overall costs. Yet NFPs believe (potentially incorrectly) that funders are mostly unwilling to fund above 20%, or even lower.
3. This underfunding of indirect costs leads to lower capability and effectiveness – Case study NFPs universally under-invested into their core capability. Compared to the case study NFPs, a corporate sector benchmark study suggested they spent twice as much per employee on key capabilities such as training, IT, quality, and marketing. This increases risk, forces charities to spend time searching for untied funding, and leads to charities deliberately introducing inefficiencies.
4. The drivers of indirect cost underfunding are complex and interrelated – the complexity of measuring NFP effectiveness, the power dynamics in the funder/fundee relationship, and a lack of consistency of measurement all contribute to this issue.