Lending to nonprofits

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

The lender needs to understand the possible imbalance between working capital funds and capital improvement funds. Most balance sheets carry the unexpended funds as cash on the asset side and an offset on the liability side. Depleting cash with the corresponding liability staying the same shows that liquidity is being drained without the underlying operational costs (current liabilities) being paid down. The greater the imbalance, the more the misuse of working capital.

Banks may be asked to "bail out" the NPO when the bills come due because the funds have been exhausted. It is imperative to have a meeting with the NPO management to help them adopt cash flow discipline. Covenants must be overlaid on the balance sheet to keep the cash and offset liability within reason. Usually one of these covenants will tie some relationship to the liability on the balance sheet that arises from deposits, tuitions, or grants that have not been expended but also show up as cash on the asset side of the balance sheet. The ratio can vary because the loan officer must evaluate how much of the monies (cash) can be used for current needs and how much has to be held back for future uses.

The controller must firmly believe and must work toward a sustainable and predictable positive cash flow after all debt payments, capital expenditures, and necessary working capital increases. He or she should budget for a surplus and not a break-even. The lender also should beware of cash flow reporting/forecasting that uses next "season's" subscriptions as this season's working capital, which would mask monies for future projects that have been already used in current operations to finance losses or cost overruns of capital projects in progress.

Conclusion

Pitfalls in lending to NPOs differ from those in lending to manufacturers or distributors. However, the risk can be controlled by a seasoned lender who keeps close ties with the NPO. In addition, there is goodwill to be gained by assisting these entities in doing good work in the many communities around the country.

Notes

(1) The following information may be found at www.irs.gov/charities/charitable/article/0,,id=960 99,00.html. "The exempt purposes set forth in IRC Section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening the burdens of government; lessening of neighborhood tensions; elimination of prejudice and discrimination; defense of human and civil rights secured by law; and combating community deterioration and juvenile delinquency. To be organized exclusively for a charitable purpose, the organization must be a corporation, community chest, fund, or foundation. A charitable trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify."