States, cities, counties, school districts, colleges and universities, hospitals, and other governmental and nonprofit organizations are responsible for funding projects for their organizations. These can include capital expenditures on roads and buildings, social welfare programs, construction of a new dormitory, a new hospital, etc.
Some of these projects require large upfront capital expenditures or cash outlays not covered in the organization's budget and not available to be paid with cash-on-hand. To finance these projects, the organization must borrow the money upfront, possibly through the capital markets, and pay the borrowed amount down over time using either taxes, project revenues, or both.
There are several sources an organization can use to fund its needs, including:
- Borrowing from a bank
- Borrowing in the capital markets
- Borrowing through federal/state financing programs
- Federal grants
- Philanthropic contributions
Example:
A rapidly-growing city needs to upgrade existing highways. It doesn’t have the funds in its budget to pay cash for these upgrades, so it will borrow money to finance the project and pay that down with tax revenues.
What’s important here?
Governmental and nonprofit organizations can borrow money in many ways to meet their funding needs, such as taking bank loans or issuing bonds to investors in the capital markets.
Bonds issued in the capital markets tend to have a lower yield than bank loans for a few reasons. First, banks set their loan yield based on a required profit margin resulting in a higher yield to the borrower. Next, bonds are typically sold in the competitive capital markets, which also drives the yield down. Finally, if a project is for the "good of the people,” a bond can be tax-exempt (from federal, state, or local income tax or a combination thereof) which will also result in a lower yield.
