When billionaire Warren Buffet recently decided to pledge more than $30 billion to the Bill and Melinda Gates Foundation, it’s a sure bet he checked out the foundation’s efficiency beforehand.

These days charitable donors from Buffet to the average minimum wage worker want to know that their money will be used efficiently and will not be wasted on fat salaries, plush offices, or expensive fundraising parties. Donors often demand that their funds be restricted to work serving the charity’s purpose, what the Internal Revenue Service calls “program services,” and not used for administrative costs.

“Savvy donors know that the most efficient charities spend at least 75% of their budgets on their programs and services and less than 25% on fundraising and administrative overhead,” said Trent Stamp of the charity-monitoring organization, Charity Navigator.

This focus on efficiency has sharpened as more data has become available on charities’ budgets and as nonprofits have begun to compete more with private businesses in the services arena.

Still, nonprofits’ executives, accountants and donors view this new focus with mixed reactions. For one thing, it makes nonprofits take a serious look at how they are spending their money, prompting them to direct more funds to the services they offer. But at the same time it has led to questionable accounting practices and an over reliance on the program services breakdown.

Nationally, seven out of 10 charities spend less than 10% of their budget on fundraising costs, less than 15% on administration costs, and at least 75% on the programs and services they exist to provide, according to Charity Navigator’s annual reviews of 20,000 charities’ tax records.

In Washington, D.C., nonprofits serving the homeless rank even higher in efficiency compared with all charities nationwide. The 57 local groups serving the homeless spend an average of 84.3% of their budgets on mission-directed program services and activities, a Street Sense review found. Only four nonprofits (7%) spend less than 70% on their program’s mission.

Local charities also are well below the national average on spending for overhead, and only two charities spend more than 20% on fundraising.

Accounting Disputes

For a nonprofit to retain its tax-exempt status, it must file an annual Form 990 with the IRS stating how much of its budget goes for each of three functions: program services, which includes mission services and activities; administration, which covers salaries, meetings, legal services, accounting, insurance, office management, auditing, publications, and distribution of an annual report; and fundraising, which covers costs of soliciting contributions and gifts, writing grant proposals, and publicizing and conducting fundraising campaigns and events.

However, many items span one or more of these categories, which raises various questions: How do you handle costs for space or a copier used for both administration and fundraising? What do you do with a mailer containing both educational material and an appeal for donations?

“Savvy nonprofits know they are judged on their program expenses and often classify most crossover expenses as program-related,” said Mark A.. Hager, a research associate in the Center on Nonprofits and Philanthropy at the Urban Institute.

“They know that donors want to believe that a minimum of their contributions is being used for administration and fundraising,’’ he said. ` “So they find ways, some legitimate and some not, to represent as many of their expenses as programmatic expenses as they can.”

Thomas J. Raffa, who heads the firm Raffa P.C., which performs accounting services for D.C. nonprofits, said that categorizing expenses is an issue of considerable dispute, and that there is little precise guidance on how to do it.

“The rules are not consistent, and organizations face competitive pressures to look good,” Raffa said. “Even the IRS, the United Way, and the Better Business Bureau differ in their accounting instructions to nonprofits. Without standards, we can’t tell which charities are truly efficient.’’

In addition, Michael D. Ward, an accountant with Walker & Co. LLP , said a nonprofit’s overhead allocation will vary with the kind of charitable work it does.

“A human services provider frequently has more employees with screening requirements for staff serving clients and thus needs more rigorous and complex human resources systems and personnel,’’ he said. “An advocacy organization, on the other hand, may have a small staff and a few key grants that support their work, so the ` ‘back office’ for human resources and accounting could be much smaller and less complex.”

At the same time, many organizations have no choice but to take the costly steps of building a database of donors and communicating with those donors.

“Organizations that provide a service that governments don’t fund may have disproportionately higher fundraising costs because it is the only way they can raise the money to support the work,” Ward said.

Why the new focus?

Attention to program expenses versus overhead has become more intense since services such as GuideStar (www.guidestar.org) started scanning IRS Form 990s and making them available to the public.

“The growing transparency of 990 data allows potential donors to examine a nonprofit's efficiency ratio,’’ Raffa said. “This has simply raised the stakes around these ratios and made them harder for nonprofits to ignore.”

Further scrutiny stems from the competition between businesses and nonprofits for performing the functions of schools, prisons, and human services. This competition creates a problem for nonprofits, says Peter Frumkin, assistant professor of public policy at Harvard's Kennedy School of Government and a senior fellow of the New America Foundation. “If the prime criterion used by public and private funders turns out to be efficiency, nonprofits are in for a lot of trouble.”

Frumkin argues that cost efficiency alone is a poor criterion for judging a charity. Donors also need to look at the more difficult issue of the quality of a nonprofit’s services, as judged by its clients and the community.

In his 2001 article, “Going beyond Efficiency” in The Nonprofit Quarterly, Frumkin wrote: “To be successful in the future, nonprofit managers will need to move the performance conversation consciously away from narrow process measures of efficiency to broader measures of program outcomes and impact, where nonprofits may have some distinctive advantages.”

In the competition for lower overhead percentages, cost cutting alone will not work, according to several experts. Frumkin, for one, noted that increasing efficiency is not a formula for sustained success in the nonprofit sector because cost-cutting moves are always easily matched by other nonprofits.

“There will always be providers willing to cut more corners, exclude difficult clients, and do what is needed to drive down costs,” he said.