A charity’s overhead costs are their administrative and fundraising costs. It is relatively common to use the proportion of a charity’s budget that’s spent on non-overhead costs (often called “program costs”) as an indicator for how good (or cost-effective) the charity is. For example, this a key criterion used in Charity Navigator's ratings.^[1]

Some use overhead costs as a proxy for effectiveness on the following rationale: What we really care about is how much a charity helps others; it‘s the charity‘s program costs, not its administrative and fundraising costs, which help others; therefore the greater the proportion of its income a charity spends on others, relative to itself, the better.

The above rationale is misguided, however, for two reasons. First, overhead ratio doesn’t measure how much the charity actually helps others. For example, a charity could be spending all its money on program costs, but if the aim of the charity is to give donuts to police officers, it still won’t do much good.

Second, having a low overhead ratio may be actively bad for a charity. Charity fundraising often gets a very good rate of return, so putting money into fundraising may allow a charity to grow faster and in the long term spend more on its programs. Administration costs often include monitoring and evaluation to find out whether a program is working, and how it could be done better.