Financing: The Benefits of Off-Balance-Sheet Financing
By Tracy Eden
two different categories of commercial financing from an accounting
perspective: on-balance-sheet financing and off-balance-sheet
financing. Understanding the difference can be critical to obtaining
the right type of commercial financing for your company.
on-balance-sheet financing is commercial financing in which
capital expenditures appear as a liability on a company’s balance
sheet. Commercial loans are the most common example: Typically, a
company will leverage an asset (such as accounts receivable) in
order to borrow money from a bank, thus creating a liability (i.e.,
the outstanding loan) that must be reported as such on the balance
off-balance-sheet financing, however, liabilities do not have to
be reported because no debt or equity is created. The most common
form of off-balance-sheet financing is an operating lease, in which
the company makes a small down payment upfront and then monthly
lease payments. When the lease term is up, the company can usually
buy the asset for a minimal amount (often just one dollar).
difference is that with an operating lease, the asset stays on the
lessor’s balance sheet. The lessee only reports the expense
associated with the use of the asset (i.e., the rental payments),
not the cost of the asset itself.
Why Does It Matter?
This might sound like technical accounting-speak that only a
CPA could appreciate. In the continuing tight credit environment,
however, off-balance-sheet financing can offer significant benefits
to any size company, from large multi-nationals to mom-and-pops.
benefits arise from the fact that off-balance-sheet financing
creates liquidity for a business while avoiding leverage, thus
improving the overall financial picture of the company. This can
help companies keep their debt-to-equity ratio low: If a company is
already leveraged, additional debt might trip a covenant to an
trade-off is that off-balance-sheet financing is usually more
expensive than traditional on-balance-sheet loans. Business owners
should work closely with their CPAs to determine whether the
benefits of off-balance-sheet financing outweigh the costs in their
Other Types of Off-Balance-Sheet Financing:
popular type of off-balance-sheet financing today is what’s known as
a sale/leaseback. Here, a business sells property it owns and then
immediately leases it back from the new owner. It can be used with
virtually any type of fixed asset, including commercial real estate,
equipment and commercial vehicles and aircraft, to name a few.
sale/leaseback can increase a company's financial flexibility and
may provide a large lump sum of cash by freeing up the equity in the
asset. This cash can then be poured back into the business to
support growth, pay down debt, acquire another business, or meet
working capital needs.
is another type of off-balance-sheet financing. Here, a business
sells its outstanding accounts receivable to a commercial finance
company, or “factor.” Typically, the factor will advance the
business between 70 and 90 percent of the value of the receivable at
the time of purchase; the balance, less the factoring fee, is
released when the invoice is collected.
an operating lease, no debt is created with factoring, thus enabling
companies to create liquidity while avoiding additional leverage.
The same kinds of off-balance-sheet benefits occur in both factoring
arrangements and operating leases.
mind that strict accounting rules must be followed when it comes to
properly distinguishing between on-balance-sheet and
off-balance-sheet financing, so you should work closely with your
CPA in this regard. But with the continued uncertainty surrounding
the economy and credit markets, it’s worth looking into the
potential benefits of off-balance-sheet financing for your company.
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