Commercial Financing – The advantages of Off-Balance-Sheet Financing
There’s two different groups of business financing from your accounting perspective: on-balance-sheet financing and off-balance-sheet financing. Comprehending the difference could be important to acquiring the best kind of commercial financing for the company.
Quite simply, on-balance-sheet financing is commercial financing by which capital expenses appear like a liability on the company’s balance sheet. Commercial loans are the most typical example: Typically, a business will leverage a good thing (for example a / r) to be able to take a loan from the bank, thus developing a liability (i.e., the outstanding loan) that must definitely be reported as a result around the balance sheet.
With off-balance-sheet financing, however, liabilities don’t have to be reported because no debt or equity is produced. The most typical type of off-balance-sheet financing is definitely an operating lease, by which the organization constitutes a small lower payment upfront after which monthly lease payments. Once the lease term expires, the organization usually can purchase the asset for any minimal amount (frequently only one dollar).
The important thing difference is the fact that by having an operating lease, the asset stays around the lessor’s balance sheet. The lessee only reports the cost connected by using the asset (i.e., the rental payments), not the price of the asset itself.
How Come It Matter?
This may seem like technical accounting-speak that just an accountant los angeles could appreciate. Within the ongoing tight credit atmosphere, however, off-balance-sheet financing can provide significant advantages to any size company, from large multi-nationals to mother-and-pops.
These benefits arise from the truth that off-balance-sheet financing creates liquidity for any business while staying away from leverage, thus increasing the overall financial picture of the organization. It will help companies maintain their debt-to-equity ratio low: If your clients are already leveraged, additional debt might trip a covenant for an existing loan.
The trade-off is the fact that off-balance-sheet financing is generally more costly than traditional on-balance-sheet loans. Business proprietors should work carefully using their CPAs to find out whether the advantages of off-balance-sheet financing over-shadow the expense within their specific situation.
Other kinds of Off-Balance-Sheet Financing
An more and more popular kind of off-balance-sheet financing today is what is known as a purchase/leaseback. Here, a company sells property it owns after which immediately leases it away from the brand new owner. You can use it with virtually any kind of fixed asset, including real estate, equipment and commercial vehicles and aircraft, to mention a couple of.
A purchase/leaseback can increase a company’s financial versatility and could give a large lump sum payment of money by creating more the equity within the asset. This cash may then be put into the business to aid growth, pay lower debt, acquire another business, or meet capital needs.
Factoring is another kind of off-balance-sheet financing. Here, a company sells its outstanding a / r to some commercial loan provider, or “factor.” Typically, the factor will advance the company between 70 and 90 % of the need for the receivable during the time of buy the balance, minus the factoring fee, is released once the invoice is collected.
As with a practical lease, no debt is produced with factoring, thus enabling companies to produce liquidity while staying away from additional leverage. Exactly the same types of off-balance-sheet benefits exist in both factoring plans and operating leases.
Bear in mind that strict accounting rules should be adopted with regards to correctly distinguishing between on-balance-sheet and off-balance-sheet financing, which means you should work carefully together with your CPA in connection with this. However with the ongoing uncertainty all around the economy and credit markets, it’s worth searching in to the potential advantages of off-balance-sheet financing for the company.