“Off-balance-sheet financing” is an accounting term for sources of financing not reported on a company balance sheet. The simplest examples are operating leases, where the company leases a piece of equipment, leaving the debt off the balance sheet with the leasing company, but having the use of the equipment.

Why Do Companies Use Off-Balance Sheet Financing?

Standard loans and equity that appear on the balance sheet impact various ratios and provide third parties with information on the financial health of an entity. A company may not wish to adversely affect these ratings or ratios by adding traditional debt or equity. One example of these ratios relates to the extent to which a company is funded by debt, which is closely monitored as it is a good indicator as to the future viability of an entity. An organization may however wish to acquire financing for projects or gain improved review by analysts. Off-balance-sheet financing is a means to achieve this goal. The financing will be classified as being off the balance sheet, with the funds required secured and the balance sheet unaffected.

What Forms Does Off-Balance Sheet Financing Take?

· Joint Ventures

· Securitization (where loans and their associated risk are transferred to a third party)

· Letters of Credit

· Special Purpose Entities (whereby assets and liabilities of a company are transferred to a different business, again with the aim of transferring risk)

· Research and Development partnerships

Controversy Resolving Around Off-Balance Sheet Financing

This technique has attracted a great deal of negative attention. There is a perception that the approach is used to artificially distort balance sheets, avoid tax and generate bonuses. The difficulty is that the debts still ultimately lie with the company. It is most infamously and closely identified with the downfall of Enron, where special purpose entities were effectively used to move debt off the balance sheet of the parent company. Hundreds of special purpose entities were created to mark billons of dollars in debt.

Accounting Controls

As a result of a number of financial scandals, off-balance-sheet financing is subject to stringent reporting rules. For instance, even though financing does not appear as a liability, it must be disclosed in the accounts and notes accompanying the balance sheet. However the approach remains controversial despite action by the accounting bodies. In spite of the negative view of the method, it remains a legal and sometimes even necessary technique.