What is off-balance-sheet financing?
Off-balance-sheet financing is a situation where you can acquire equipment without it appearing on your balance sheet*. There are a number of advantages to be gained from off-balance-sheet financing, as noted below.
What does it mean to say that equipment doesn't appear on my balance sheet?
It means your new equipment is considered neither an asset nor a liability. Off-balance-sheet financing can occur when you acquire your equipment through an operating lease.
What are the advantages of off-balance-sheet financing?
The advantages are significant:
- Off-balance-sheet financing generally has no effect on your borrowing capacity. (An installment loan, on the other hand, reduces the amount you can subsequently borrow.)
- You'll see a higher reported return on your assets.
- Your finance ratios should remain intact. (When you get a loan, the equipment goes on the asset side of the balance sheet and the loan appears on the liability side. This generally changes your finance ratios, often for the worse.)
What does that mean to my bottom line?
It means your business will be less encumbered by debt, more liquid, and more profitable. In addition, your business's balance sheet will appear stronger financially.
Is it legal?
It might sound too good to be true, but off-balance-sheet financing is perfectly legal, as long as you follow the guidelines set by the Financial Accounting Standards Board (FASB). According to these guidelines, the only lease that qualifies is an operating lease. If your lease falls into a different category, you probably won't qualify for off-balance-sheet financing.
What are the guidelines?
There are four rules that determine if a lease is an operating lease.
- Ownership cannot automatically transfer to the user at the end of the lease. Your intent must be to use and return the equipment. A "dollar-out" lease would not qualify for off-balance-sheet financing.
- There cannot be a "bargain purchase" option (generally defined as a purchase option of less than 20%).
- The term of the lease cannot be greater than 75% of the equipment's useful life.
- The present value of the minimum lease payments must be less than 90% of the equipment's fair market value
How do you determine the present value?
The FASB uses a formula that's too complex to show here. However, you can use this table to determine an estimated payment** and preliminary FASB calculation. Enter your numbers in the boxes, using your tab key to move from one box to the next. The spreadsheet will calculate an estimated*** payment.
What must I do to qualify for off-balance-sheet financing?
It's simple. Make sure your lease is structured as an operating lease, according to each of the FASB guidelines above.
*The information on this page is offered for illustration purposes only, and should not be considered as legal, tax, or accounting advice.
**This is a preliminary calculation, which can be affected by a number of other factors. See your accountant for details.
***Payments will vary according to the type of lease, credit worthiness, term, residual value, etc.
Always discuss your equipment acquisition plans with a qualified accountant.
