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Finance: What is off balance sheet financing? 4 Views


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What is off balance sheet financing? Hit play to find out.

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Transcript

00:00

finance a la shmoop what is off-balance-sheet financing well it's

00:08

like money from a fourth dimension money is being borrowed stuff is being bought [money floating in the universe]

00:14

but somehow on the normally filed books and numbers of 10-qs and k's and other [stack of paper on table]

00:19

filings well it's like that song she's not there companies want to show as

00:26

little debt as possible on their books for a variety of reasons like go well

00:30

they don't want to look vulnerable to their competitors if a big luscious

00:33

jewel comes along that they can buy and they have too much debt already on their [gigantic diamond]

00:37

books they also want to pay the cheapest rent on their debt possible and less

00:42

debt means less risk in paying back the dough so that makes companies look less

00:47

leveraged and more able to take on more debt and well make shareholders happier [clipboard]

00:52

so when companies need things they will actively look to find financially

00:56

efficient ways of buying them and a lot of times that involves off-balance-sheet

01:01

financing our friendly tractor smelting company needs a new factory it can buy

01:08

one for a hundred million dollars huge debt on its books if it borrowed all [factory for sale]

01:13

hundred million risk all kinds of other liabilities as well well if the company

01:18

was sitting on a fat stack of a billion dollars than was you know burning a hole [businessman sitting on a pile of money]

01:22

in its pocket well then this might be a viable thing to do and they just write a

01:25

check but that last Union strike cost him a fortune in the company and its [union workers on strike]

01:30

creditors are worried there might be another strike which would fully

01:33

bankrupt the company and put everyone out of a job and make the debt loaned to

01:38

the company to buy that factory while fully bust so what can the company do [balloon of debt pops]

01:42

instead well they need this Factory the old one is slowly but surely slipping

01:46

into the muck surrounding the neighboring a nuclear plant there yes [factory sinking into green goo]

01:49

sorry well one type of off-balance-sheet financing comes from leasing that is the

01:55

company could take on an operating lease on an already existing tractor smelting

02:00

Factory that has just been sitting there ten miles down the road a victim of the

02:04

last Union strike from a competitor which actually did bankrupt that company

02:09

so the smelting Factory is great in new and it's just waiting to be leased and

02:14

the banks that now own it would be only too delighted to get at least some cash

02:19

flow coming back to them and lease it to the tractor smelting company here yeah [leasing agreement changes hands]

02:24

that one so from an accounting perspective there

02:26

isn't debt that appears on the balance sheet when they form an operating lease

02:30

to take over that Factory in essence the lease is just rent and appears as normal

02:35

vanilla expense it's off balance sheet it is essentially financing an operating

02:41

asset without triggering debt covenants that make that long-term commitment to

02:47

leasing the factory look like it is in fact legally dead or it's not existing

02:51

think about the way in which accounting is handled for a five-year lease on a

02:54

building that leased covers 60 months said they'll say ten grand a month or

02:58

six hundred thousand dollars worth of financial commitment or obligation paid

03:02

monthly well legally the company is inextricably bound to paying its rent

03:06

for the entire duration of the lease is that money considered debt well in this

03:11

case no but it's not far from being treated as an off-balance sheet event

03:15

and in practice conservative companies actually put a line for lease

03:19

obligations as one of their most current and long-term sets of liabilities and

03:24

you can imagine them getting out of that with one little trick in there that well

03:29

should the company give 30 days notice they'd be out of obligation for the

03:33

least in which case well they wouldn't have to report it as a long-term kind of

03:38

lease liability and that would help it be off balance sheet they wouldn't

03:42

really have to note it in that sense all right Alex Enron for a thousand so yes

03:47

if you don't remember because you were still in the womb doing backstroke Enron [pictures of baby in womb]

03:50

was one of the great off-balance sheet fraudulent chicanery exercises in [Enron logo]

03:55

American business history the company deployed some of the most evilly clever

03:59

accounting practices in history to hide the fact that it in fact owed massive [zombie]

04:04

debt obligations which were buried as being quote off-balance sheet assets

04:08

unquote well how did they pull off this magic

04:11

well the shell game revolved largely around sometimes real and often faked

04:15

partnerships where Enron would choose at will to be viewed either as a majority

04:20

or a minority participant in a transaction than had a loan or debt

04:25

attached to it such that with smoke and mirrors it could make it appear as if it

04:29

owned the debt liability and more often than not the debt liability was in fact

04:34

owned by its shield partners so it kind of went away as a debt obligation

04:38

phantom the precept did not reporting the real numbers came from the ability

04:43

to call the debt liabilities off balance sheet the perception was that the

04:47

company had an asset that was growing quickly but in fact the company was

04:51

borrowing a dollar to buy 50 Cent's of notional revenue the bottom line

04:56

off-balance sheet transactions are only so far off in the long arm of law and

05:00

the collection agency comes with the baseball bats reach into all kinds of

05:04

nooks and crannies around the globe and yeah here's what happened to the guy

05:07

orchestrating the whole Enron dance

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