The name itself is rather self-explanatory. This kind of financing helps with business expenses which aren’t in the balance sheet of a company. A lot of people think that it is illegal, however, it is a completely legal practice if used properly.
Off-balance sheet vs traditional financing
Every business has a variety of different expenses such as research, operating costs, leases, etc. To be able to fund these expenses, companies usually look to get debt financing. A typical bank loan for a small business includes debt financing where a company gets a debt for their funding.
With traditional financing, where debt is involved, everything is documented on a balance sheet. However, if a business looks to finance their own projects, it is not required for the debt to be added to the cash flow statement, or balance sheet. This is where off-balance sheet financing comes into play.
Off-balance sheet financing benefits
With this type of financing, a company can reduce its’ debt to improve the ratio of debt to equity. This instantly improves the company’s credit and lenders will look at it in a more positive way. When you have a lower ratio, it will be easier to get debt financing and traditional loans.
At the same time, with traditional debt financing, the company is obligated to keep its debt to equity ratio on a certain level or face consequences. Off-balance sheet financing also allows you to get more money while not jeopardizing previous loans.
The bottom line
Off-balance sheet financing is discretionary but there are also certain rules that must be followed when used. Apart from these minimal rules, it can be difficult for an investor to analyze the financial position of the company. This is why it is important to analyze your financial situation before getting OBS financing.