Off-Balance-Sheet Financing

A form of financing in which large capital expenditures are kept off of a company's balance sheet through various classification methods. Companies will often use off-balance-sheet financing to keep their debt to equity (D/E) and leverage ratios low, especially if the inclusion of a large expenditure would break negative debt covenants.

Investopedia Says:
Contrast to loans, debt and equity, which do appear on the balance sheet. Examples of off-balance-sheet financing include joint ventures, research and development partnerships, and operating leases (rather than purchases of capital equipment).

Operating leases are one of the most common forms of off-balance-sheet financing. In these cases, the asset itself is kept on the lessor's balance sheet, and the lessee reports only the required rental expense for use of the asset. Generally Accepted Accounting Principles in the U.S. have set numerous rules for companies to follow in determining whether a lease should be capitalized (included on the balance sheet) or expensed.

This term came into popular use during the Enron bankruptcy. Many of the energy traders' problems stemmed from setting up inappropriate off-balance-sheet entities.

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This article defines some typical off-balance-sheet items and discusses when they are justified and when they are misleading. Off-Balance-Sheet Entities: The Good, The Bad And The Ugly
Understand how financing through operating leases, synthetic leases, and securitizations affects companies' image of performance. Uncovering Hidden Debt
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Financing that does not add debt on a balance sheet and thus does not affect borrowing capacity as it would be determined by financial ratios. The most common example would be a lease structured as an Operating Lease rather than a Capital Lease and where management's intent is, in fact, to acquire an asset and corresponding liability without reflecting either on its balance sheet. Other examples include the sale of receivables with recourse,Take-Or-Pay Contracts and bank financial instruments such as guarantees, letters of credit, and loan commitments. Generally Accepted Accounting Principles (GAAP) require that information be provided in financial statements about off-balance-sheet financing involving credit, market, and liquidity risk.

Manner of obtaining funds, often through a long-term, noncancelable lease accounted for as an operating lease. Since the lease does not meet any of the four criteria for a Capital Lease, the present value of the lease obligation is not presented on the lessee's balance sheet.