October 21, 2010 | Read Time: 3 minutes
I’ve spent much of my adult life studying and practicing the art and occasional science of finance. As a result, I felt smugly smart about my understanding of how money works—until I landed on what a colleague refers to as “planet nonprofit.”
In the nonprofit world, everything seems upside-down. Capital is sparse, cash reserves are difficult to accrue, and, most curious, debt is feared and reviled. Debt, the life force of my previous existence in the business world, is largely inaccessible and ineffective in my new parallel universe. And this troubled me greatly when I started working with nonprofits.
Don’t get me wrong: I don’t worship at the altar of the leveraged loan. In fact, the best financial advice I ever received was from a poster on the wall of a convenience store. It said: “In God we trust, all others pay cash.”
The ability to generate, save, and reinvest cash is critical to the success of any organization, regardless of its mission or tax status. When cash is short, an organization faces heightened financial risk. Debt is not and never will be a substitute for revenue.
Cash, however, has a sometimes murky meaning for nonprofits. It is often not liquid and its flow is often restricted. In fact, a major source of nonprofit cash— grants that finance specific projects—is usually restricted. Grant money typically must be used to finance specified projects or functions—and often the nonprofit must wait for the money, meaning it has to pay first and wait for reimbursement later. Cash is much more fluid in the business world. Debt helps businesses bridge the span between the timing of program expenses (outflow) and the receipt of cash (inflow). In essence, debt finances the opportunity to generate cash.
Debt can also be used by nonprofits to extend the utility and life of cash surpluses. For most nonprofits, building adequate cash surpluses can be a slow process. Debt allows organizations to acquire assets like buildings or vehicles in a timely manner without depleting all of their accumulated cash. That cash can then be used to create reserve funds for contingency, growth, and change—things that debt generally won’t accommodate.
When debt gets ugly (and, believe me, it sometimes does), it is usually the result of improper care and feeding. Debt most often goes astray right out of the gate because many lenders simply do not understand nonprofit economics. In addition, credit is often priced higher for nonprofit groups. When an organization’s board consists of community volunteers and its most valuable asset is playground equipment, it might not look like the best credit risk in the eyes of a banker.
Should nonprofit groups run from debt? Absolutely not. But they must approach debt carefully and thoughtfully. Nonprofits must embrace the financial literacy and discipline needed to manage debt. Philanthropy must continue to invest in creating financial institutions that are socially responsible and responsive and that provide direct credit to nonprofits.
Everyone who cares about a civil society must recognize the real currency that the nonprofit world trades in—making lives better.
Isn’t that worth financing?
