Once customers have paid up, the factor pays the company the balance due minus a fee for services rendered.In this way, a business can collect what is owed while outsourcing the risk of default.
Often, companies set up special-purpose vehicles (SPVs) or special-purpose entities (SPEs) that have their own balance sheets, and companies then place the assets or liabilities in question on the SPEs' balance sheets.
Off-balance-sheet financing is most often used in order to comply with financial .
The Enron scandal was one of the first developments to bring the use of off-balance-sheet entities to the public's attention.
In Enron's case, the company would build an asset such as a power plant and immediately claim the projected profit on its books even though it hadn't made one dime from it.
For most companies, off-balance sheet items exist in relation to financing, enabling the company to maintain compliance with existing financial covenants.
Solved Problems On Balance Sheet The Perfect College Essay
Off-balance sheet items are also used to share the risks and benefits of assets and liabilities with other companies, as in the case of joint venture (JV) projects.Accounts receivable (AR) represents a considerable liability for many companies.This asset category is reserved for funds that have not yet been received from customers, so the possibility of default is high.If the revenuefrom the power plant was less than the projected amount, instead of taking the loss, the company would then transfer these assets to an off-the-books corporation, where the loss would go unreported.An OBS operating lease is one in which the lessor retains the leased asset on its balance sheet.An operating lease, used in off-balance sheet financing (OBSF), is a good example of a common off-balance sheet item.Assume that a company has an established line of credit with a bank whose financial covenant condition stipulates that the company must maintain its debt-to-assets ratio below a specified level.Off-balance sheet items are typically those not owned by or are a direct obligation of the company.For example, when loans are securitized and sold off as investments, the secured debt is often kept off the bank's books.Instead of listing this risk-laden asset on its own balance sheet, companies can essentially sell this asset to another company, called a factor, which then acquires the risk associated with the asset.The factor pays the company a percentage of the total value of all AR upfront and takes care of collection.