How to prepare loan proposals for not-for-profit clients.

CPAs can provide the critical help such organizations need to increase the chances their requests for funds will be approved.

The steps not-for-profit organizations take to obtain bank loans are similar to those taken by any organization. But there are a few significant differences, and whether a loan will be approved or rejected often depends on recognizing those differences. This article examines the special steps nonprofits should take to improve the likelihood of receiving a loan approval and the role CPAs can play in the process.

Generally, the burden of finding bank financing is assigned to the manager of a nonprofit organization, and that person--often a member of the clergy or a person who specializes in servicing humanitarian projects--usually is unskilled in financial matters. This is where a CPA can step in and help.

As is the case with for-profit companies, the primary tool for obtaining a loan is the formal loan proposal document. It furnishes bankers with the information needed to judge an organization's credit worthiness and demonstrates that the organization understands the serious consequences of a bank loan. However, not-for-profit enterprises should not assume banks will grant them loans solely because their missions are worthwhile. As discussed later, churches or humanitarian organizations actually are at a disadvantage.

THE PROBLEM OF PLEDGES

The timing sections of nonprofits' proposals differ little from those of for-profit companies. Bankers want to know how much money is needed and when it will be needed, and, if the loan proceeds are to be used for new construction, they need a calendar of anticipated disbursements corresponding to each construction phase.

There is one major difference, however: Nonprofits must forecast income from pledges. Pledges are promises of future financial support from a nonprofit's members and supporters. They can be made on an annual or multiyear basis, be in the form of cash or other consideration and, if legally enforceable, should be reflected on the balance sheet in accordance with generally accepted accounting principles.

Addressing the issue of accounting for pledge income, paragraph 15 of Financial Accounting Standards Board Statement no. 116, Accounting for Contributions Received and Contributions Made, which is effective for fiscal years beginning after December 15, 1994, for large nonprofits says "unconditional promises to give with payments due in future periods shall be reported as restrieted support unless explicit donor stipulations or circumstances surrounding the receipt of a promise make clear that the donor intended it to be used to support activities of the current period." Affected pledges include, for example, those made over several years to support major building campaigns. While fulfilling the requirement to report multiperiod pledges, CPAs could collect important timing information for a nonprofit employer or client to determine when loan funds will be needed and when the loan can be repaid.

Most bankers are interested in knowing details about the pledges. CPAs can convey a positive image of a nonprofit client's or employer's financial sophistication by preparing a comprehensive pledge profile even before the bank asks for one. The following information should be included:

* Who are the pledgers?

* Can their promises of future donations be relied on?

If pledges come from a wide assortment of supporters, rather than from just one or two persons, banks probably will want an analysis of the pledges to determine the reliability of their support. If the number of supporters is small, bankers also may ask that their names be disclosed. Deciding whether to provide such information may be a sensitive issue for some organizations, and the board of directors should be alerted to the concern beforehand. On the other hand, if there are many donors and each carries a proportionate share of a project's costs, bankers probably will not request individual identities.

When meeting with bankers, CPAs should be ready to describe their clients' or employers' procedures for collecting unpaid pledges and their past collections experience. Lenders know some pledges will not be honored and the lack of a definite plan to collect from delinquent pledgers could reflect negatively on a nonprofit's managers. Of course, GAAP requires recording an allowance for uncollectible pledges on the balance sheet, so CPAs should be prepared to address bankers' concerns.

INCOME STRATEGY

Other sources of funds should be addressed in loan proposals as well--for example, dues, subscriptions, membership fees, newsletter advertising income and income from meals or other services provided. Loan proposals should address how future revenues will be influenced by the use of borrowed funds. For example, if a loan will be used to expand facilities, membership fees may be expected to grow. Since such estimates could influence the payback of a loan, they are of vital interest to bankers.

PLANNING A PAYBACK

A strategy for retiring the debt is a must. Including a debt repayment schedule in loan proposals suggests the applicant has taken a serious look at the economic feasibility of the loan. Projected revenue should be figured conservatively in the repayment schedule; forecasting revenue growth that exceeds historical performance will raise a red flag when the loan application is evaluated.

As is the case with for-profit loan proposals, nonprofits are expected to provide audited financial statements for the past three years, along with interim statements not more than 60 days old. Since the interim statements for most small nonprofit organizations are budget-oriented, cash-basis financials, they may exclude expense items such as depreciation and accruals. CPAs may need to explain how the interim financials differ from the audited statements prepared on a GAAP basis. Nonprofits also need to explain fully any interfund receivables and payables listed on the balance sheet by disclosing when the interfund accounts become due and how the obligations will be paid. Permanent loans between funds should be reclassified as equity transfers when it is clear the board of directors does not anticipate repayment.

Nonprofit financial statements typically play a different role in the evaluation of a loan proposal than for-profit financials do because nonprofits' statements primarily are designed to disclose fiduciary effectiveness and compliance--not profitability. Although nonprofits' financials are used to evaluate their ability to incur more debt, bankers must look beyond the financial data provided to get a feel for how an applicant really is doing. Since not-for-profits typically are service-oriented, not profit-oriented, loan proposals must relate the financial statement data to measurable service objectives achieved--for example, the number of homeless people housed this year over last, the number of degrees awarded, the attendance trend over the past three years, etc. These are the measures of a nonprofit's success and disclosure of such data is essential to tell the whole story of its operations.

MISSION IS CRITICAL

Loan proposals also should include a history of the organization and its mission statement. The mission statement establishes a nonprofit's reason for existence. It should be concise and understandable to anyone outside the organization. Brief resumes of key personnel, including board members, should be included, too. Bankers are most interested in the qualifications and abilities of directors because personal guarantees from board members might be required before a loan is granted. The personnel data section should include each person's name, occupation, education and length of service with the organization.

A QUESTION OF OWNERSHIP

Collateral usually is a crucial element of both for-profit and nonprofit loan requests. An added wrinkle, however, is the legal ownership of assets offered as collateral. For example, many churches use and maintain their assets "in trust" for their denominations. Recent court cases have confirmed that ownership rights to local affiliates' assets rest with the national denomination when such a claim is written in its bylaws. Therefore, before churches or other organizations in such a position can offer an asset as collateral, ownership rights should be investigated fully and explained to the bank. A not-for-profit employer or client might assume it has full privilege to such assets without ever having researched the matter formally. Since approval from a national or regional once may be required, it's worth checking out the matter before a banker asks.

CPAs also should estimate a nonprofit's anticipated average bank balance on deposit with the potential lender. Bankers calculate a loan's interest rate using this figure. If a not-for-profit organization has endowments, computing the average deposit balance will be more complex, but it could be well worth the effort. The potential for large endowment fund deposits makes a loan more attractive to the bank and therefore deserves inclusion in the submittal.

BANKERS' CHOICE

While deciding what to include in a loan proposal is vital, deciding to whom to present the document can be even more important. The banker who is handed a loan proposal should be familiar with and supportive of the organization's mission. A cold contact from a charitable enterprise looking for a loan rarely yields positive results; the main reason is the unique risk involved in lending to nonprofits. One hazard is the limited number of collections options open to a bank should a nonprofit default on a loan. Even though banks can enhance their public image by granting loans to popular charities, the opposite also is true should they need to recover a nonprofit's bad debt. When explaining why nonprofit loans are risky, one bank's senior vice-president said, "No one wants to foreclose on a church."

As a result, a nonprofit should make it a point to develop a long-term business relationship with a bank and a key banker. It even should consider inviting a banker to join the board of directors. A banker can become a key source of financial counsel and encouragement. With a bank executive on the board, the process of obtaining a loan could be simplified greatly. Lenders should view the granting of a loan as the beginning of a partnership with the organization and be committed to meeting its financial needs beyond the current loan request.

Most charitable organizations place considerable emphasis on fund-raising to meet financial goals. Some of the techniques used to increase donations have transformed this necessary chore into an art form. Knowing how to raise funds through bank financing also should be a part of nonprofit managers' arsenal. CPAs who serve nonprofits as employees, board members or professional advisers can anticipate their informational needs and lead the way in preparing a successful loan proposal.

EXECUTIVE SUMMARY

* MANAGERS OF NONPROFITS generally are not skilled in financial matters. When such organizations seek bank loans, a CPA can step in and help.

* NONPROFITS SHOULD NOT assume banks will grant them loans solely because their missions are worthwhile.

* JUST LIKE FOR-PROFIT companies, nonprofits initiate the process of obtaining a loan by preparing formal loan proposals. But in the case of nonprofits, banks need other information about funds pledged to pay off the loan.

* IF THERE ARE JUST a handful of pledgers, banks may want to know their identities. The disclosure of pledgers' names may be sensitive and require consideration by a nonprofit's directors.

* CPAs SHOULD BE READY to describe a nonprofit's procedures for collecting unpaid pledges and its past collections experience. They should avoid requesting loans from bankers who are not familiar with or supportive of them. Cold contacts often result in rejections.

* THERE ARE UNIQUE risks involved in lending to nonprofits. One is the limited number of collections options open to banks when nonprofits default on loans. For this reason, many banks are not interested in handling nonprofit loan requests.

KEVIN W. TAYLOR, CPA, is the business manager of the Eastminster Presbyterian Church in Wichita, Kansas. He is a member of the American Institute of CPAs.