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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
Full Transcript
- 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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