Any experienced business owner understands that there are several ways to record revenue and expenses. One unique accounting technique involves keeping certain figures off of the balance sheet. The process is known as off-balance sheet financing and involves several notable pros and cons. Those who are unsure whether it is an effective method for their business can keep reading for some helpful tips and advice.
What Is the Purpose?
Most businesses opt for an off-balance sheet financing approach in order to optimize their debt-to-equity ratio and increase the likelihood of a favorable loan agreement. Since it is possible that a major expenditure can make a company appear less capable of repaying a loan, keeping that purchase off of the balance sheet is an excellent way to maintain a positive appearance.
In addition to loans, a balance sheet without these figures recorded therein is also more appealing to potential investors. It is worth noting that any such financing process should be arranged with the approval of both the borrower and lender.
How Does It Work?
There are several rules to follow when pursuing this option. A few of the most common strategies include issuing guarantees to creditors, engaging in joint business opportunities, and selling assets according to appropriate means that will allow them to be kept off of the balance sheet. In many cases, a company will opt to rent or lease receivables for a period and then purchase them when the terms of that arrangement reach their conclusion, thus avoiding the accounting expense of making a larger purchase at the outset.
What Are the Risks?
Although there are clear benefits to engaging in off-balance sheet financing, it is not an appropriate response to all business decisions. For example, if a business uses this technique to hide the fact that it is overleveraged with risky investments, the information can emerge at an inopportune time and spell financial disaster for the entire organization. There are also some important restrictions at play whenever such a method is being pursued, so anyone considering it should consult with a trusted accountant for advice and guidance.