Using Lines of Credit, Loans, and Mortgages

Each month, Nonprofits Assistance Fund hosts the Financial Management Network.  These free, informal gatherings are opportunities for members of the nonprofit community to get together to discuss different financial topics and network with peers. Key takeaways from these discussions will be posted and form an archive to help promote healthy financial practices.

Notes from Using Lines of Credit, Loans & Mortgages (Oct 22, 2008)

Many nonprofit organizations need credit to cover cash flow gaps or fund expansion, but employing the right credit strategy can be challenging.  Participants in the October Financial Management Network asked questions and shared how their organizations have analyzed their own financial situation, accessed lines of credit, and built relationships with banks.

Start with a Cash Flow Projection

  • Many nonprofits have regular cash flow gaps that can be caused by:
    • Seasonal variation in services
    • Timing of restricted funds
    • Large lump-sum contract reimbursements
  • Cash flow projections are a useful management tool in that they can inform nonprofit leaders of future opportunities and/or financial challenges.
  • Chart your own cash flow using Nonprofits Assistance Fund's Cash Flow Template.
  • Common forms of credit include:
    • Line of credit
    • Balloon loan, with a large amount of principal due at maturity (e.g. bridge loan) 
    • Term loan
      • Fully amortizing
      • Mortgage for real estate purchases, equipment purchases, or capital expansion

Sources of Repayment for a Loan or Line of Credit

  • How will debt be repaid?
  • How reliable are those future sources of income?
  • Nonprofits Assistance Fund recommends using a cash flow projection to inform this conversation.

Line of Credit - Factors to Consider

  • Closing costs
  • Fees
  • Interest rate
  • Terms
    • Often has an annual maturity date, so parties can check-in and discuss extending the line of credit
  • Collateral assigned from the organization to the bank
  • Prepayment penalties
  • Commonly required to pay down to zero balance for a defined period of time during the term of the line of credit 

Line of Credit vs. Cash Reserve

By accumulating and saving surplus revenue over time, some nonprofits have effectively established a cash operating reserve. When faced with a need for cash, these organizations weigh the decision of whether or not to use a line of credit or to draw on reserve funds.

  • Common reasons organizations opt for using a line of credit, rather than reserves:
    • A perception that the situation may not be sufficiently urgent to merit use of emergency reserve funds
    • Concern that reserve funds won't be replenished
    • A line of credit can help establish a positive banking relationship
    • Favorable terms associated with a line of credit (e.g. low interest rates)
  • Common reasons organizations choose to use reserves funds, rather than a line of credit:
    • Operating reserves were established for the type of cash flow challenges that the organization currently faces
    • Using reserve funds is less expensive than paying the fees and interest associated with a line of credit
    • The organization is unable to obtain the necessary credit from a lending institution
  • Other considerations when using cash reserves:
    • Have a conversation at the board level to determine the purpose and best use of your cash reserve.
    • Every organization has a different philosophy towards cash reserves - establish or review ground rules and expectations in your written financial policies.
    • For more information on cash reserves, see Operating Reserves.

Bank Relationships

  • Establish a good relationship with your lending institution.
  • Small and/or young organizations' bank relationships might be based on the personal credit history of a founder, Executive Director, or board member. As the organization grows, work to re-orient the relationship towards the organization, rather than the person.
  • It may be difficult to establish personal relationships, especially at large banks, but be persistent. These relationships are important when your organization needs credit.
  • Find a lending institution that fits your needs. For example, different banks have different policies regarding credit cards for organization employees.

Collateral

Collateral is an asset that is pledged to a lender until a loan is repaid. In case of default, the lender legally owns the right to obtain or sell the collateral to repay the loan.

  • The credit offered by a financial institution can vary based on risk, collateral.
  • If an organization keeps large deposits in a depository account or has a well-established relationship with a financial institution, they might be able to access credit with lower fees and/or with lower interest rates.
  • Nonprofits often do not have significant collateral. However, collateral is just one of four common underwriting criteria that most financial institutions consider:
    • Collateral
    • Ability to repay
      • Use your cash flow projection to show future sources of income
    • Financial history
    • Management ability
  • Projecting your future cash flow and applying for credit well in advance can demonstrate good management and a solid understanding of your financial history and sources of income.
  • Find a credit vehicle that fits your financial condition. Shorter term bridge loans may be appropriate if a longer term loan is too risky.

Transformational Lending

More information on loans and lines of credit from Nonprofits Assistance Fund:

Interested in Learning More?

View our Resource Collection or check out the Discussion Archive for notes from other Financial Management Networks.

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