Your Complete Guide to Off-balance-sheet financing (OBS)
Off- balance-sheet financing has in the past received a bad reputation but sometimes it can be the right finance solution for your company. Below is your complete guide to off-balance-sheet financing.
When to use it and when not to use it!!
To learn more talk to a GRENKE financial expert today!
What is off-balance-sheet financing (OBS)?
Off-balance sheet financing is an accounting practice where companies record certain assets or liabilities in a way that keeps them from appearing on the balance sheet. This makes the balance sheet look cleaner and healthier.
Why is it so attractive?
It is used to keep debt to equity ratios low. OBS financing is attractive to all companies, particularly those who already have high debt levels. Including a large expenditure on the balance sheet might break an agreement between a business and a creditor.
These agreements or covenants would have been put in place as a condition for receiving a commercial loan. Banks will impose higher charges on a business they consider more likely to default on payments. Partnerships in areas like R&D are attractive because it's expensive and could take a long time before reaching completion. The pharmaceutical industry is a good example where R&D for new drugs takes years.
How does OBS financing affect investors?
A healthy-looking balance sheet is likely to attract more investors. The challenge for prospective investors is analysing financial statements closely enough to discover any OBS financing and hence disclose the company’s total debt.
Is OBS financing legitimate?
It is legitimate provided GAAP (generally accepted accounting principles) are followed. There are considerable consequences for not applying these rules.
What are the financial reporting requirements?
Companies must disclose off-balance sheet items of financing in the note of their financial statements – they are not invisible. Clever investors know to study these notes carefully and spot keywords.
How many types of off-balance-sheet financing are there?
Operating leases is one of the most common forms. To avoid buying equipment or property outright, a company leases it and then buys it at a minimal price at the end of the lease period. This means they only record the rental cost on their books resulting in lower liabilities on the balance sheet.
Engaging in partnerships is another common way to hide liabilities. When a company is in a partnership, even if it has a controlling interest, it doesn’t have to show the partnership’s liabilities on its balance sheet.
What are the pros and cons of off-balance-sheet financing?
Keeping debt off the balance sheet allows a company to appear more creditworthy or appealing to potential investors. On the other hand, it can also be a misrepresentation of the firm's true financial structure.
What are examples of off-balance-sheet financing going wrong?
Probably the highest-profile example is Enron, the American energy giant which went bankrupt in 2001 after using OBS financing to hide mountains of debt. Enron hid its liabilities by creating partnerships. It gave OBS financing a bad reputation.
Talk to GRENKE Today!
As one of the leading financial service providers in the Irish market, GRENKE’s slogan is
‘Fast, Forward, Finance’. GRENKE offers entrepreneurs fast and flexible financial
solutions through a range of services including leasing and invoice finance. We match the
perfect financial solution to your unique business needs, from small businesses to large
enterprises.
Over the last 40 years, GRENKE has provided leasing to numerous styles of businesses
and organisations; sole traders, partnerships, public and private limited companies,
associations and organisations, medical, health, and educational providers, public hospitals, semi-state institutions, Government bodies and so much
more.
Our expertise and strong market position are no coincidence. If you are a business owner
looking for financial solutions in Ireland or advice on fast and flexible financing, talk to a
GRENKE Account Manager today.
