How to Work With Your Banker Amidst Change
With more than 25 years of banking experience and an equal tenure serving the Portland, Ore., community with Catholic Charities, Impact NW and other organizations, Kathy shares this advice for how to help your banker to give your organization as much credit as possible.
In the past, nonprofits tended to be asset rich with limited need for credit. Times have changed, however, now that constrained governmental funding, and lower charitable contributions are continuing for the foreseeable future. No banker wants to be the bad guy or to say no to an organization that is doing good work in the community, but a nonprofit borrower that starts to struggle can fall quickly from an acceptable risk to an unacceptable risk, threatening the viability of the organization and the essential services they are providing to the community.
This article seeks to provide several ideas for how a nonprofit can address the impact of these trends in order to help a bank to assist this transitional period through providing credit lines or term loans. The suggestions and the bank's perspective on financial performance can be grouped under the two distinct concepts: conservative financial management and institutional agility.
Conservative financial management
Banks perceive nonprofits to be a riskier type of borrower in general. The fundamentals of cash flow and collateral are the same as for-profit customers. But without an equity owner who has other resources and a profit motive, nonprofits tend to require more balance sheet cushion than other borrowers do.
Help your banker help you by mitigating as much risk as possible:
- The executive director needs to be a skilled administrator, as well as an enthusiastic visionary. If you don't have a strong numbers sense, ensure that you have hired the right person to head up the finance department and allow them a strong voice in advising you.
- There's no replacement for a strong board of directors. Be sure that the board includes business people who understand financial statements, and that it is not a rubber stamp to your proposals as the executive director.
- Financial statements should be produced regularly and should be reviewed and approved by the board. A dashboard report should be developed for the board that measures both balance sheet and income statement drivers, comparing them to last year same period, and this year's budget.
- Be sure that your loan agreement financial covenants are tailored to your nonprofit's financial statements and the drivers of your business. Make sure that your lender understands nonprofit accounting for revenue recognition and for restricted and temporarily restricted funds (SFAS 116and 117.) Your cash flow analysis and financial covenants, especially those related to liquidity and debt service coverage, should be focused on unrestricted funds
- In times of rapid change and uncertainty, the need for a base budgets and some cash cushion is greater than ever. A minimum of 60 days cash on hand -- or a solid plan and commitment to get there is a base requirement. The budget should be at a detailed enough level that unbudgeted revenue declines or expense increases can be identified at the program level.
Discussing poor financial performance is uncomfortable for everyone. By their nature, nonprofit leaders believe in hope and a better future. You can ask your lender to provide support from appropriate sources, but you should not expect the bank to accept continuing operating losses for more than one fiscal period, or to make an exception to their credit risk management practices due to the importance of your mission.
In order to make the lender comfortable with an operating loss, you need to provide a plan that shows how you will return to profitability within the next fiscal period:
- Provide a revised forecast/budget and a cash-flow projection early on, and apply downside scenarios and create trigger points for cost or service reductions. Communicate those with your board and major stakeholders. Track your performance to budget and meet regularly with the stakeholders about below-plan performance.
- Track financial performance to the plan, as well as to the same period last year. Loss of a major grant or funding source needs to be addressed quickly with a reduction in expense or a drawdown of board-restricted funds until a replacement revenue source can be obtained, especially for those nonprofits who budget to a zero net income level.
- Don't use an accounts receivable secured line of credit (which is a short term facility) to fund an operating loss. A credit line has typically only 12 months or less until maturity, and the lender may not choose to extend the credit facility if you are losing money.
- If you do need to fund a short term operating loss, look for additional support (such as providing a lien on a building) which will allow the bank to mitigate some of the risk of the credit during the higher risk period while your nonprofit returns to break even or a positive net income.
- Make sure that you use a payroll service to ensure that payroll taxes are current, as your lender will become very concerned about this type of tax lien that comes before the bank's lien on assets.
- Make sure that you keep your banker informed of any bad news or a likely operating loss. Surprises erode their trust and your lender's ability to work through a tough time, especially if they hear your bad news from a third party first. Control the message and show your banker that you are solutions-oriented by informing them as a negative situation develops and providing your plan of action to resolve it.
Nonprofits play a vital role in our economy, and banks can comfortably support them with both deposit and credit products. Our healthcare and social service nonprofits in particular are facing a sustained period of funding constraints and rapid business model changes, which make liquidity and access to credit more important than before. Risk is inherent in lending to for profits and nonprofits. Finding Having a banker who understands nonprofit accounting policies and sector risk will help alleviate unwarranted headaches and help you manage your credit requirements.
Kathy Swift is senior vice president and commercial banking officer for Pacific Continental Bank.