The Statement of Functional Expenses (SFE) is a cornerstone report for nonprofit organizations, offering transparency into how funds are allocated by breaking down expenses into functional categories. While it serves a vital role in compliance, the SFE is much more than that—it’s a powerful tool for decision-making, storytelling, and strategic planning.

What Is a Statement of Functional Expenses?

A Statement of Functional Expenses (SFE) is a detailed financial report that categorizes an organization's expenses by both natural classification (e.g., salaries, rent, supplies) and functional classification (program services, administration, and fundraising).

To fully understand the SFE, it’s important to grasp the purpose of each functional category and how they relate to the organization’s mission and operations:

  • Program Services: These are the expenses directly tied to your mission. For example, if your nonprofit focuses on literacy, costs for books, teacher salaries, and tutoring spaces would be included here.

  • Administration (or Management & General): These are administrative costs that keep the organization operational, such as office rent, utilities, and software subscriptions.

  • Fundraising: These are costs associated with raising funds, such as event expenses, donor communications, and grant writing.

The primary purpose of the SFE is to provide a clear picture of how donor dollars are utilized. This level of transparency builds trust with donors, stakeholders, and grantors while ensuring compliance with IRS requirements.

Understanding Expense Allocation

Some expenses touch every part of your nonprofit—like rent, utilities, or office supplies—you can't simply assign them to one functional category. Instead, you'll allocation expenses to fairly distribute these shared costs across program services, administration, and fundraising. Here are the most common ways nonprofits divide up these organization-wide expenses:

Common Allocation Methods:

1. Direct Identification 

  • Expenses directly tied to a specific function are easily categorized

  • Example: A program coordinator's salary goes directly to Program Services

  • Simplest and most straightforward allocation method

2. Time and Effort Tracking 

  • Used for employees working across multiple functions

  • Requires periodic time studies or employee time tracking

  • Staff record the percentage of time spent in each functional area

  • Provides the most accurate allocation for mixed-role employees

3. Square Footage Allocation 

  • Useful for shared expenses like rent and utilities

  • Allocate costs based on the physical space used by each functional area

  • Calculate by measuring the square footage dedicated to each function

4. Headcount Allocation 

  • Distribute shared expenses based on the number of employees in each functional category

  • Simple method when other allocation bases are difficult to determine

Best Practices for Expense Allocation

  • Consistency: Use the same allocation method consistently across reporting periods

  • Documentation: Maintain clear documentation of allocation methodologies

  • Regular Review: Periodically reassess allocation methods as organizational structure changes

  • Transparency: Be prepared to explain allocation methods to stakeholders

How to Read the SFE

Focus on Percentages

One key insight comes from calculating the percentage of each functional expense category against total expenses. In the example report above, it would be:

  • Program Services: 67%

  • Administration: 22%

  • Fundraising: 11%

A commonly cited guideline for nonprofits is the 65/35 rule, which suggests that at least 65% of spending should go toward program expenses, while overhead costs—such as administration and fundraising—should make up no more than 35%. However, every nonprofit is unique, and spending might not always align with this rule. Instead of just focusing on the ration, prioritize directing  funds toward programs and reducing unnecessary administrative or fundraising costs.

Identify Trends Over Time

Review SFEs from multiple periods to spot trends. Is program spending increasing? Are fundraising costs staying reasonable? These trends can indicate organizational health.

Compare to Peers

Look at SFEs from similar organizations to benchmark your spending patterns. Are you spending significantly more or less on fundraising or administration?

Insights For Nonprofit Leaders

  1. Mission Focus
    If program service expenses are low, it might signal mission drift. Leaders should ensure resources align with the organization’s goals.

  2. Operational Efficiency
    High administrative expenses could indicate inefficiency, but it’s important to remember that some administrative costs are necessary for sustainability.

  3. Fundraising Effectiveness
    Analyze fundraising costs relative to income generated. If fundraising isn’t yielding a significant return, it might be time to reevaluate strategies.

  4. Budgeting Guidance
    Use the SFE to guide future budgeting decisions. For example, if supplies are a growing expense, it might be worth negotiating with vendors or seeking in-kind donations.

  5. Stakeholder Communication
    This report can help you craft narratives for grant proposals and donor appeals, showcasing how effectively your organization uses funds to achieve its mission.

The Statement of Functional Expense is more than just a financial document. It's a strategic tool that reflects your nonprofit's commitment to financial transparency, operational efficiency, and mission-driven work.

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Other Important Financial Reports

Statement of Financial Position: A Leader's Guide

Statement of Activities: Your Nonprofit’s Story of Impact

Nonprofit Cash Flow Stmt: Managing Your Mission’s Money Wisely