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Summary of chapter 47 : Off-balance sheet financing
 
  Companies have always tried to remove assets and/or liabilities from their balance sheets in order to reduce the apparent debt burden or base financing on specific assets, thereby reducing, theoretically, the overall cost of debt.

Five objectives may prompt a company to use off balance sheet financing:

find a new or less-expensive source of financing, backed by assets that present the precise risk profile sought by certain investors;
transfer a risk that the company is no longer willing to run;
re-engineer the company so as to increase flexibility;
reduce taxes;
reduce real or apparent debt burden and gearing ratios.

The principal techniques are as follows:

discounting of bills of exchange, no-recourse discounting, factoring;
leasing and sale-leaseback;
defeasance;
securitisation;
outsourcing.

Accounting treatment in this instance is fundamental, because it determines whether or not the company must consolidate an asset (or a liability). IAS standards are more strict than US standards as IAS emphasise principles whereas US GAAP put forward strict ratios. In contrast, the “letter-of-the-law” approach of US standards make it possible to structure a transaction so as to circumvent the principles. In any event, the spectacular bankruptcy of Enron, which used off balance sheet financing to report fictitious profits and hide debt, will cause both sets of standards to be tightened up significantly. Every cloud has a silver lining!

Off balance sheet financing often leads to lower debt, but at the cost of lower or more volatile future profits because of the significantly increasing cash breakeven point.

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