Lending to nonprofits

RMA Journal, The, March, 2005 by Donald P. Johnson

Liquidity and Fund-raising

To properly assess the liquidity issues involved in NPOs, the lender must be familiar with the amount of funds available, where the funds come from, and whether there are any restrictions--governmental or from the contributor--that affect their use.

Should fund-raising be used to add liquidity or revenue, the lender should set aside a separate facility to watch for retirement of debt from the fired-raising. This will effect monitoring on one side to ensure the proper source and application on the other side. It is imperative to warn the NPO about pitfalls of multiple fundraising programs, which will always result in the organization asking for more bank loans to bridge the gap of cash imbalance due to overworked donors. Fundraising is not a legal obligation in the sense of business receivables. The lender must make an educated guess about the reliability of projections, which can be accomplished by analyzing similar, successful campaigns in the past.

Another watch item is the "restricted funds" accounts. When an NPO experiences cash flow problems, it may access those funds to overcome the temporary setback, gambling that it can replenish the funds before a reporting period. The problem with this approach is the possible forfeiture of the funds due to the conditions the granting organization placed on the NPO. This would result, at best, in having to return the previously restricted funds from operating accounts or, at worst, in financial and legal action from government or private donor sources, which will be discussed later.

A lender must ask for any existing margin accounts or side letters using funds as collateral. Sometimes the use of restricted funds can be masked by borrowing against (leveraging) funds without actually having a withdrawal. The NPO might leverage these restricted funds between reporting periods (usually quarters and year end) and reverse the funds by using accounts payable or by drawing down on any room in the line, which would mask problems from the casual analyst.

Grants. Grants often come with definite parameters for their use. NPOs may use grant funds to offset operating expenses by absorbing costs roughly similar to the grant's purpose but not advancing the expected project. This is similar to a builder being ahead of its draw and, at the end, not having the funds to finish. Reports on the expenditure of funds versus capital projects need to be reviewed on a regular basis to ensure the source and application are being handled as the grantor expects. The grantor will always have a final report and inspection of funded projects. However, the grantor may or may not do periodic reviews.

Expenditure review becomes crucial when a grantor has no site tour or accounting review for extended periods of time. Discovery of misuse after a year or more may not be resolvable and could have severe financial and/or legal ramifications for the NPO.

When the review is done, any irregularities not only could bring public relations problems to the borrower, but also could have greater legal ramifications because funds--government as well as private--could bring the board into a possible "misappropriation of funds" charge. The lender must understand fund accounting and can take comfort from a CFO who tracks each grant not only to its application, but to the progress of each event as well. The NPO should at all times be able to account to a grantor and its banker that monies are being used appropriately. The controller must have a handle on the accounting for restricted funds and the discipline to keep them out of the working-capital monies stream. There are good software products on the market today that can handle these calculations, but beyond the calculations, it is necessary to visit the various projects and compare completion with the work schedule and with the cash balances for a backup.