Financing Nonprofit Growth, Part 5: High-Volume, Low-Margin

This is part 5 of our series on financing nonprofit growth. You can see the first four articles below:

• Why Growth?
• The Menu Of Options
• Playing Catchup
• The Balance Sheet

Here's the basic concept: Fun Finance is a high-volume, low-margin business, meaning that they make very little per loan and therefore have to make a LOT of loans to cover their costs.  The good news is that their margins are good.  Here's how we can calculate that:

- Take the average interest rate they charge.  Let's call it 20%
- Subtract the average default rate, which we'll set at 7%
- Subtract the "cost of capital," a fancy term of the average interest paid to investors; let's say 3%

We are now left with 10%, which has to be enough to cover the cost of marketing, underwriting, loan closing, loan servicing, and administration (rent, utilities, software).  Let's assume that the average margin on a loan (also known as gross profit), in dollars, comes to $594
We can now try to understand what it will take for Fun Finance to become self-sufficient:

Year 1:

• Average loan size of 1,000.7
• 375 loans
• $6,231 interest income (remember that if you make a loan, say, in June of year 1, you will earn very little interest on that loan in that calendar year)
• $2 million operating costs

Fun Finance borrows $2 million to cover the operating difference

Year 2:

• Average loan size of $1,051.68
• 1,125 loans
• $102,464 interest income
• $3.1 million operating costs

Fun Finance borrows another $3 million

Year 3:

• Average loan size of $1,083.23
• 3,375 loans
• $427,126 interest income
• $5.2 million operating costs

Fun Finance borrowers another $4.8 million

Year 4:

• Average loan size of $1,086.98
• 10,125 loans
• $1.4 million interest income
• $6.4 million operating costs

Fun Finance borrows another $5 million

Year 5:

• Average loan size of $1,119.59
• 17,719 loans
• $4.5 million interest income
• $5.5 million operating costs

Fun Finance $1.5 million

Year 6:

• Average loan size of $1,244.69
• 22,148 loans
• $9.3 million interest income
• $10.7 million operating costs

Fun Finance takes out one final loan for operating in the amount of $1.4 million

Year 7:

• Average loan size of $1,282.04
• 22,148 loans
• $17.6 million interest income
• $14 million operating costs

$3.6 million profit

Year 8:

• Average loan size of $1,320.50
• 22,148 loans
• $23 million interest income
• $19 million operating costs

$4 million profit

Year 9:

• Average loan size of $1,360.11
• 22,148 loans
• $26 million interest income
• $21 million operating costs

$5 million profit

Year 10:

• Average loan size of $1,400.91
• 22,148 loans
• $18 million interest income
• $17  million operating costs

$1 million profit

These numbers seem daunting.  Over first six years, Fun Finance has to borrow nearly $22 million for operations.  During that same time, the organization makes 52,000 loans totaling over $60 million dollars.  Still, at the end of the 10 years, not only has Fun Finance paid back all of the money it has borrowed for operations, but it has ended up with net income of $20 million; funds that it can use to lower interest rates, offer other products and services to the poor, increase its loan pool and improve customer service.

In the next post, the final in our series, we will examine these numbers more closely so as to make sense of them!