Question

Explain (and give an example of) how a company may use off-balance sheet financing to its advantage.

Answer 1

Off balance sheet items are those assets and liabilities that will not be appearing on the balance sheet of the company but they will still be the Assets and liabilities of the company so they will be not directly owned or directly having an obligation the company but they can be used by the company to improve its creditworthiness and financial health as there can be use of these assets to to increase the overall profit and growth of the company.

company can be using of balance sheet item to its own advantage by using some of the most common off balance sheet items like-

A. operating lease will be done by the company in which the company will be leading the Asset only and it will be helping the company in order to generate profits for itself and increase the cash flows as well.

B. company can also enter into the leaseback agreement in which the company can sell the Asset to the another entity and then they will be leasing the same property back from the new owner and it will help the company in order to reduce the fixed cost.

The company can even solve various financial problem by using the subsidiary or a special purpose entity which will be purchasing various assets from the company and then leasing back to the company through the operating lease while legal ownership is retained by the separate entity so company will be having a flexibility and the company does not have to recognise additional debt or list the equipment at asset on the balance sheet.

Company can even sell its assets to another company which are generally done in form of factoring and it will be trying to factor its data which will be paying the company a percentage of overall upfront fees and the factor will be trying to solving the liquidaty problems associated with the company.