Off-Balance-Sheet Financing

Off-balance-sheet financing

Financing that is not shown as a liability on a company's balance sheet.

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off-balance-sheet financing

An accounting technique in which a debt for which a company is obligated does not appear on the company's balance sheet as a liability. Keeping debt off the balance sheet allows a company to appear more creditworthy but misrepresents the firm's financial structure to creditors, shareholders, and the public. The sudden collapse of energy-trading giant Enron Corporation is attributed in large part to the firm's off-balance-sheet financing through multiple partnerships.

Case Study The sudden collapse of energy-trading giant Enron Corporation caught regulators, politicians, lenders, analysts, and the public by surprise. In large part the surprise resulted from the billions of dollars of debt the company had been able to hide by using off-balance-sheet financing through hundreds of partnerships. The hidden liabilities allowed Enron to maintain the appearance of a rapidly growing but financially stable company until near the very end, when bankruptcy was imminent. Enron's financial arrangements were complicated and sometimes entailed transferring overvalued assets to partnerships which it had a controlling interest in but was not required to include on its own balance sheet. The partnerships, with minimal equity capital from outside investors, raised most of their capital from loans using Enron stock, transferred assets, or pledges from Enron as collateral. Although Enron used aggressive accounting methods, many of the accounting techniques it employed were not illegal. For this the accounting profession was called to task.

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Off-Balance-Sheet Financing

A type of company financing that does not appear as a liability on the company's balance sheet. A company may engage in off-balance-sheet financing if it wishes to keep its debt-equity ratio low and thereby appear as if it is carrying little debt. This, in turn, makes the company look more creditworthy than it would otherwise. A common form of off-balance-sheet financing is an operating lease, in which a company rents, rather than buys, a capital asset. In an operating lease, the company must record only the rental payments, and not the whole cost of the asset. While off-balance-sheet financing is permissible, it can become unsustainable and can hide a company's true financial state. The term came into common parlance when Enron collapsed in the wake of excessive off-balance-sheet financing. See also: Enron scandal.

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Off-Balance-Sheet Financing

What Does Off-Balance-Sheet Financing Mean?

A form of financing in which large capital expenditures are kept off a company's balance sheet through various classification methods. Companies often use off-balance-sheet financing to keep their debtto-equity (D/E) and leverage ratios low, especially if the inclusion of a large expenditure would break negative debt covenants.

Investopedia explains Off-Balance-Sheet Financing

Examples of off-balance-sheet financing include joint ventures, research and development partnerships, and operating leases (rather than purchases of capital equipment). Operating leases are one of the most common forms of off-balance-sheet financing. In these cases, the asset is kept on the lessor's balance sheet, and the lessee reports only the required rental expense for use of the asset. Generally accepted accounting principles (GAAP) in the United States set numerous rules regarding whether a lease should be capitalized (included on the balance sheet) or expensed. This term came into popular use during the Enron bankruptcy. Many energy traders' problems stemmed from setting up inappropriate off-balance-sheet entities.

Related Terms:
• Balance Sheet
• Capital Structure
• Debt/Equity Ratio
• Float
• Generally Accepted Accounting Principles—GAAP