Off Balance Sheet Funding, Great Tool for CFO’s. Why?
Whenever we talk about this term off balance sheet funding, it gives a bit scary thought. Especially if you are an investor in any business & you do not have much information on the actual liabilities of it, including liabilities remaining off balance sheet. Who knows it better than Enron investors.
But if done with a right intent it may help CFO’s to bring more efficiency into their businesses.
What is Off Balance Sheet Funding?
In a very simple term, off balance sheet funding is an arrangement between lender & borrower to get financing by leveraging its balance sheet strength but does not requires him to record entire liability on its balance sheet. Basically, it is an accounting technique in which a debt for which a company is obligated but it does not appear on the Company’s balance sheet as liability.
What are the benefits of off balance sheet funding?
Off balance sheet funding helps CFO’s to leverage their balance sheet strength & finance their business requirements, both long term and short term. It helps CFO’s to keep their debt equity ratio low, create more liquidity or honour terms of any specific contracts restricting their borrowing limits.
What are the structures available under off balance sheet funding?
Under long term off balance sheet funding the structure available is to opt for operating lease instead buying an asset under financing. This arrangement benefit companies to only book monthly lease rental & does not record entire liability for the cost of the asset, which in turn helps keeping lower debt on the balance sheet.
Although while opting for this arrangement, CFO’s must ensure that terms of lease contract do not qualify it to be termed as capital lease which in that case may then defeat the whole benefit of off balance sheet funding.
Further to fund working capital requirements for eg. carrying inventory for longer period (especially during off season), you may get the inventory funded directly by bank to the supplier.
In this case, the borrower remains supplier until the buyer actually takes the delivery of the inventory, although the exposure is taken by the bank basis buyer’s balance sheet & repayment strength.
The benefit under this structure is buyer does not need to carry higher inventory & debt on his balance sheet. This arrangement may further also help in keeping the financing costs low if the goods/ supplier qualifies under priority sector lending program of the bank.
Finally, instruments of off–balance sheet capital have earned themselves a bad name, with the mismanagement of such capital by Enron, Barring Banks, and others. But at the same time as I mentioned in the beginning, it is undeniable that such capital adds strategic value by securing value-added risk, if and only if it is managed properly. So ensure transparency & follow all disclosure norms, off balance sheet funding may come out as wonder tool for your business.
Amit Bhuttan is a Lead CFO of CFO Ladder LLP, a business consulting firm that helps early-stage, small and middle-market businesses grow through design and execution of sound business strategies.