Although non-profit organizations can't make a profit, it doesn't mean they can't take on debt. And there are times when it can be necessary for a non-profit organization to use debt. Whether you handle debt and investments for a non-profit organization or see debt as a potential hedge for other investment activities, non-profit debt should be one of the financial tools you consider.
Reasons for Debt
Non-profit organizations take on debt for many of the same reasons as a for-profit business. Although a non-profit is exempt from income taxes, it relies on donations and grants to pay for the resources it needs to carry out its mission. Debt for a non-profit can pay for expansion, cover the costs of marketing its services, or generate good will among the community that supports it. Non-profits have access to debt primarily through bank loans, which require collateral or rely on the organization's credit history.
Hedging for Non-Profits
A non-profit organization can use debt to hedge against financial risks, or take steps to hedge against the risks posed by debt. For example, a non-profit might rely on an endowment and an annual level of donations when it plans its budgets. However, to hedge against the risk of donations falling short of projections, the non-profit can make a policy of borrowing money to cover its essential costs. It can use donations to pay down that debt, and fund additional programs. Once a non-profit has debt, it must account for it as a liability in its financial accounting. To cover the future cost of debt, a non-profit can use donations and grants to make investments that pay interest to offset -- or hedge against -- the cost of borrowing.
Debt as a Hedge
Outside investors can also use non-profit debt as a hedge. Every time a non-profit borrows money, it creates an asset for a bank or investor that stands to receive payments on the debt. Loaning money directly to a non-profit, or buying non-profit debt securities through a secondary market, allows you to profit as the non-profit pays off its debt. Selecting a non-profit with a solid financial position and income from various sources, such as trusts, donations, grants and an established fundraising network, is essential to using non-profit debt as a secure hedge.
A policy for non-profit debt should account for the risk factors that are unique to non-profit organizations. Non-profits can't issue stock to raise capital. They also rely on others for funding, which means that government budget cuts, loss of corporate donors, or periods of financial hardship for individual donors can all impact revenue. Rising costs also impact non-profits, which must pay for resources, facilities and staff at the same rates that apply to businesses. These factors make it even more important for non-profits to have hedge policies for their debt, and for investors to consider the details before relying on non-profit debt as a hedge against investment risks.
- Jupiterimages/Creatas/Getty Images