Social enterprises are businesses - they need to make a profit to compete in the market, be able to invest in their social aims and they need to be sustainable. Many enterprises are looking to become more independent from public grants and are seeking instead to source other avenues of funding or financial packages.

Being sustainable requires effective planning and robust financial management, as well as avoiding dependence on too few funding sources. This requires an understanding of financial strategy and the types of funding or finance that is available. It is important that you review your financial needs as most finance providers are likely to conduct a financial assessment of your organisation.

While each finance provider will use different calculations to assess sustainability, some of the most common considerations are listed below:

Working capital: is there sufficient cash flow or finance to cover the gap between receiving cash from sales or grants and paying for operational expenses and amounts due? In particular, a potential provider will look at any significant accounts receivable or grants expected, to determine the risk of non-payment.

Self-sufficiency: what proportion of the organisation’s expenses is covered by earned income versus grant revenue? What are the historical trends and the enterprise’s expectations to achieve and maintain self-sufficiency? Some finance providers may have a cap on the proportion of grant support they will accept.

Liquidity: does the social enterprise have enough cash on an ongoing basis to meet operational needs? Finance providers may look at how many days or months of cash (or items like client invoices that can readily become cash) are available and compare that to expenses and amounts due over the same period.

Debt service coverage: what cash will the social enterprise generate in comparison to the debt incurred and will there be sufficient cash on a regular basis to meet debt repayments?

Capitalisation refers to the way in which the assets of the enterprise are funded, typically with various forms of debt and equity. Even grants that are funding assets are considered to be capitalised – whether as debt (because they have stipulations that could possibly require the enterprise to pay back the grant) or equity. For enterprises that historically have been grant funded, capitalisation may be an unfamiliar concept. Lenders want to see that there is sufficient equity to provide a cushion of capital that the enterprise can draw upon in case of problems. If the enterprise falls into difficulties, lenders get paid ahead of equity investors (shareholders). Therefore, the more equity there is available, the more likely it is that a specific lender will get paid as there will be fewer lenders in line for whatever assets or cash is available.

Lenders may have specific debt to equity ratios for the overall enterprise or the specific project/asset being financed. These ratios may become part of the financial covenants that the enterprise must adhere to throughout the life of the loan. Equity investors want to see sufficient leverage, in order to provide a return and to minimise dilution of their return with any new equity raised in the future. In contrast to lenders, equity investors generally want to see a higher ratio of debt to equity as this will boost the return on equity. However, they will also want to see that the enterprise has an appropriate capital base to service its needs in the medium term (e.g. for the next five years or longer) and that the financial costs of borrowing do not put too heavy a burden on the enterprise.

Sources: For trading income, finance providers will evaluate the clients and the reliability of the enterprise’s revenue. They will assess whether there will be recurring income due to the nature of the operations, or if there is a need to find new clients. Are there long-term relationships or contracts in place? What is the percentage of revenue from grants? A provider will want to see how secure these grants are (again looking at the historical record), the risk of delays in receiving grants, and assess the risk that the grants will not be renewed. This analysis is part of the assessment of self sufficiency and sustainability.

Diversity of sources: A provider will also determine the diversity of an organisation’s revenue sources, looking for example at whether the enterprise is reliant on one customer for a large proportion of its income. If so, what is the risk that this revenue source will disappear and other sources will not be found? Having a large number of clients is often considered more stable as the impact of losing any one client will be smaller. Again, the finance provider is assessing the risk profile of the enterprise’s business model and in particular whether the assumed income sources that make up the cash flow projections will be available to support repayment of a loan or return on equity.

Loan to value of property: If property is available to put up as collateral, what is the market value of this property in relationship to the size of the loan? Finance providers want to see that the value is sufficiently large to cover the complications and costs that would be incurred if the property needs to be sold as a means of repaying the loan. They often have a set limit on the amount they will lend, for example 60% of the value of the property (the percentage will vary by finance provider and an assessment of the marketability of the property). Similar calculations would also be performed with other forms of collateral, such as equipment or guarantees.

Finance providers look at historic and expected trends in the enterprise’s financial position, hoping to see improvements in key areas such as:

• Cost/income ratio – potential that more cash is available to repay a loan, plough back into operations or to pay to equity investors. This ratio is also used in assessing the trend in self-sufficiency; 
• Self-sufficiency – less dependence on grants. While some finance providers may be comfortable with continued grant dependence, if considered sustainable, others will want to see that your organisation is self-sufficient or an analysis of when that may occur; 
• Revenue, cash flow and income – it is easier to sell a positive story, where all the key financial indicators are improving over time. Stability and predictability are also important indicators of risk.

Of course, trends are not always positive and all enterprises may experience dips, whether due to economic cycles, loss of a significant grant or revenue source, the seasonal nature of the business or other factors. It is important to be able to explain any variability. The higher the variability and less predictable the future of the enterprise, the more risky it is for a finance provider. More risk in turn affects the terms of finance and the type of product that is most appropriate.