Five Minutes for Finance - Administrative and Indirect Costs
Administrative vs. Indirect Costs in Nonprofit Organizations: What’s the Difference and Why Does It Matter?
For nonprofit organizations, understanding and accurately reporting costs is critical not only for internal management but also for maintaining credibility with funders, donors, and regulators. Two terms that often cause confusion—administrative costs and indirect costs—are sometimes mistakenly used interchangeably. In reality, they refer to different types of expenses, and understanding their distinctions is key for budgeting, grant proposals, and financial transparency.
Defining Administrative Costs
Administrative costs, sometimes called management and general expenses, refer specifically to the costs associated with the overall management and administration of the organization as a whole. These are the costs required to keep the organization functioning but are not directly tied to delivering a specific program or service.
Common examples of administrative costs include:
Executive staff salaries (e.g., Executive Director, Finance Director)
Accounting and auditing services
Human resources and legal services
Office management
Board meetings and governance activities
In essence, administrative costs represent the infrastructure that supports the entire organization’s operations, regardless of which program is being delivered.
Defining Indirect Costs
Indirect costs, also known as overhead costs, are broader and include all costs that cannot be directly assigned to a specific project, program, or activity—but are still necessary for the organization to function. Indirect costs encompass administrative costs but also extend to other shared resources that benefit multiple programs simultaneously.
Common examples of indirect costs include:
Rent and utilities for office space shared by all programs
IT infrastructure and general office equipment and supplies
Depreciation of shared assets
Salaries of administrative staff (already mentioned)
General office supplies and facility maintenance
Organization-wide insurance
In short:
All administrative costs are indirect costs, but not all indirect costs are administrative costs.
For example, the cost of rent for an office space used by both program staff and administrators is an indirect cost, but not necessarily an administrative cost. The salary of a finance manager, on the other hand, is both an administrative and an indirect cost.
Why the Distinction Matters
Grant Compliance and Reimbursement: Many grantmakers, especially government funders, distinguish between indirect costs and administrative costs when determining what they are willing to reimburse. Some grants allow recovery of indirect costs using a negotiated Indirect Cost Rate (ICR), which covers both administrative and other shared costs. Being clear on definitions ensures accurate and compliant reporting.
Budgeting and Cost Allocation: Nonprofits need to properly allocate costs across programs to understand the true cost of each activity and ensure sustainability. Misclassifying costs can lead to underfunding essential support functions or overloading programs with inappropriate charges.
Transparency and Donor Relations: Donors are increasingly savvy and interested in how their contributions are used. Clear and accurate reporting of both administrative and indirect costs helps build trust, demonstrate accountability, and counteracts outdated myths that “overhead” spending is wasteful.
IRS Reporting (Form 990): Nonprofits must report expenses by function (program, management & general, fundraising) on IRS Form 990. Accurate distinction between administrative and other indirect costs ensures compliance with regulatory requirements.
Practical Tips for Nonprofits
Develop a clear cost allocation plan: Ensure that indirect costs (both administrative and other shared costs) are fairly distributed across programs based on reasonable metrics (e.g., staff time, square footage usage) and that this methodology is documented in writing.
Negotiate an Indirect Cost Rate (if applicable): For nonprofits working with federal or other large funders, obtaining a negotiated ICR can make recovering indirect costs simpler and more predictable.
Educate stakeholders: Help board members, donors, and funders understand that administrative and indirect costs are not inherently “bad.” They are necessary investments in organizational capacity and long-term mission delivery.
Track costs accurately: Use accounting software and consistent practices to correctly categorize administrative, indirect, and direct costs.
Conclusion
While administrative and indirect costs overlap, they are not identical. Understanding the distinction empowers nonprofit leaders to manage finances more effectively, comply with grant requirements, and make the case that strong infrastructure is fundamental to mission success. After all, a nonprofit cannot serve its community without robust systems, sound management, and healthy operational support.
About this Series
Subsequent articles in this series will cover other topics related to nonprofit financial management. Here is a list of, with links to, previous articles:
About the Author
For over 30 years, Robert Pascual has been a leader in nonprofit financial management as a CFO, consultant, conference speaker and educator. He holds an MBA from the Haas School of Business at the University of California and is the founder and principal of Robert Pascual, MBA LLC. He has worked with small, mid-size, and large nonprofit organizations spanning the fields of education, workforce development, housing, health, philanthropy, social services, media, fiscal sponsorship, nature, and the environment. Each of these organizations has faced both unique and common challenges, some of which are probably similar to ones that you wrestle with.