Liabilities - Effects Of Off-Balance Sheet Financing Transactions On Financial Ratios

  • Take-or-pay contracts and throughput agreements
    These types of agreements effectively allow companies to keep some operation assets and liabilities off the balance sheet. As a result, in the analysis of a company's financial statement, the balance sheet should be restated and include the present value of the minimum future payments to both the assets and liabilities section of the balance sheet. If this is not done, the debt-to-equity and asset-turnover ratio will be overstated.
  • Sales of receivables
    Sales of receivables artificially reduce the receivables and short-term borrowing needs. Furthermore, they distort the pattern of cash flow from operations as the firm receives cash earlier than it would if the receivables had been collected in due course.

    In addition, the potential liability associated with the buyer-recourse provision is not displayed on the balance sheet. From an analytical point of view, the current-asset ratio, working capital and receivable turnover will be overstated.

    On the other hand, the leverage ratios such as debt-to-equity will be too high. The reported income will also be too high because if it did not sell its receivables, the company would have had to borrow the funds it acquired from the sale of the receivables to finance its current operations.

    Analysts should adjust the balance sheet by adding back the amount of accounts receivables sold and increase short-term borrowing by an equal amount. Furthermore, the income statement needs to be restated and include the interest expense that would have been incurred by the firm had it not sold its receivables and borrowed the money instead.

Accounting For Leases


Related Articles
  1. Forex Education

    6. Analyze With Ratios

    Learning to read the balance sheet can provide great insight into the financial strength of a company.
  2. Markets

    Fundamental Analysis: The Balance Sheet

    By Ben McClureInvestors often overlook the balance sheet. Assets and liabilities aren't nearly as sexy as revenue and earnings. While earnings are important, they don't tell the whole story. ...
  3. Professionals

    Types Of Off-Balance-Sheet Financing

    CFA Level 1 - Types Of Off-Balance-Sheet Financing. Learn the characteristics of various off-balance-sheet financing practices. Includes descriptions of each type and possible consequences.
  4. Forex Education

    Reading The Balance Sheet

    Learning to read the balance sheet can provide great insight into the financial strength of a company.
  5. Investing Basics

    5 Tips For Reading A Balance Sheet

    If you know how to read it, the balance sheet provides valuable information on a potential investment.
  6. Professionals

    Financial Statement Analysis

    Financial Statement Analysis
  7. Professionals

    The Balance Sheet

    Find out how to read this financial statement, and what it says about a company.
  8. Professionals

    Business: Balance Sheet and Income Statement

    Business: Balance Sheet and Income Statement
  9. Forex Education

    5 Tips For Reading A Balance Sheet

    The balance sheet, along with the income and cash flow statements, is an important tool for investors to gain insight into a company and its operations.
  10. Active Trading

    Value Investing: Finding Value In Financial Reports And Balance Sheets

    There is plenty of information about a company that you'll want to know as a value investor, but that you can't get from a casual glance at a stock quote or from reading most stock market ...
RELATED TERMS
  1. Balance Sheet

    A financial statement that summarizes a company's assets, liabilities ...
  2. Activity Ratios

    Accounting ratios that measure a firm's ability to convert different ...
  3. Credit

    1. A contractual agreement in which a borrower receives something ...
  4. Common Size Balance Sheet

    A balance sheet that displays both the numeric value of all entries, ...
  5. Off Balance Sheet - OBS

    An asset or debt that does not appear on a company's balance ...
  6. Clean Balance Sheet

    A company's financial statement that summarizes its assets, liabilities ...
RELATED FAQS
  1. Does the balance sheet always balance?

    Yes, a balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities ... Read Answer >>
  2. What is the difference between a balance sheet and a cash flow statement?

    Understand the difference between a balance sheet and an income statement. Learn the three components of each of the financial ... Read Answer >>
  3. How should investors interpret accounts receivable information on a company's balance ...

    Analyze accounts receivable information on a company's balance sheet carefully. Receivables offer confidence of future cash ... Read Answer >>
  4. What's the difference between an income statement and a balance sheet approach?

    Understand more about the principle purposes and primary differences between a company's income statement and its balance ... Read Answer >>
  5. How are the three major financial statements related to each other?

    Learn why investors analyze a company's financial statements, and how the income statement, balance sheet and cash flow statement ... Read Answer >>
  6. What is the difference between an income statement and a balance sheet?

    Find the current value of a business by reading the balance statement and determine whether operations are efficient by analyzing ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center