Commercial financing – Benefits of off-balance sheet financing

There are two different categories of commercial funding from an accounting perspective: funding on balance sheet and off-balance sheet financing. The understanding of the difference can be essential to obtaining the good type of commercial financing of your company.

In simple terms, balance sheet financing is a commercial funding in which investment expenditures appear as a responsibility for the balance sheet of a company. Commercial loans are the most common example: typically a company will take advantage of an asset (such as customer accounts) to borrow money from a bank, creating a liability (that is to say The current loan) to be reported as such on the balance sheet.

With off-balance sheet financing, however, responsibilities should not be reported because no debt or equity is created. The most common form of off-balance sheet financing is an operational lease, in which the company carries out a low initial deposit, and then monthly rental payments. When the term lease is in place, the company can usually buy assets for a minimum quantity (often a dollar).

The main difference is that with an operational lease, the asset remains on the lessor’s balance sheet. The tenant reports only the expense associated with the use of the asset (ie rental payments) and not the cost of the asset itself.

Why is it important?

This might seem like technical accounting – talk only a CPA could appreciate. In pursuit of the tight credit environment, however, off-balance sheet financing can offer significant benefits for all major companies, major multinationals to mother-and-pop.

These benefits stem from the fact that off-balance sheet financing creates cash for a business while avoiding leverage, thus improving the company’s overall financial situation. This can help companies maintain their debt-to-equity ratio: if a company is already exploited, an additional debt could trigger an alliance to an existing loan.

The compromise is that off-balance sheet financing is generally more expensive than traditional balance sheet loans. Corporate owners should work closely with their CPA to determine whether the benefits of off-balance sheet financing outweigh the costs of their specific situation.

Other types of off-balance sheet financing

A type of financing increasingly popular off balance sheet financing is today what is called a sale / lease. Here, a company sells a property that it has, then fuck the new owner immediately. 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.

A sale / bailback can increase the financial flexibility of a business and provide a large lump sum of money by releasing equity in assets. This money can then be paid into the company to support growth, pay the debt, acquire another company or meet working capital requirements.

Factoring is another type of off-balance sheet financing. Here, a company sells its accounts in circulation to a business financing company or “factor”. As a general rule, the factor will make progress between 70 and 90% of the value of the claim at the time of purchase; The balance, the less factoring charges, are released when the invoice is collected.

As with an operational lease, no debt is created with factorization, allowing companies to create liquidity while avoiding an additional leverage effect. The same types of off-balance sheet benefits occur in factoring arrangements and operating leases.

Remember that strict accounting rules should be followed when it comes to distinguishing correctly between funding for balance sheets and off-balance sheet, so you need to work closely with your CPA in this regard. But with the persistent uncertainty surrounding the economy and credit markets, it is worth considering the potential benefits of off-balance sheet financing for your business.

Sylas Tiana
the authorSylas Tiana