Off-Balance-Sheet Financing

DEFINITION of 'Off-Balance-Sheet Financing'

A form of financing in which large capital expenditures are kept off of a company's balance sheet through various classification methods. Companies will often use off-balance-sheet financing to keep their debt to equity (D/E) and leverage ratios low, especially if the inclusion of a large expenditure would break negative debt covenants.

BREAKING DOWN 'Off-Balance-Sheet Financing'

Contrast to loans, debt and equity, which do appear on the balance sheet. Examples of off-balance-sheet financing include joint ventures, research and development partnerships, and operating leases (rather than purchases of capital equipment).

Operating leases are one of the most common forms of off-balance-sheet financing. In these cases, the asset itself is kept on the lessor's balance sheet, and the lessee reports only the required rental expense for use of the asset. Generally Accepted Accounting Principles in the U.S. have set numerous rules for companies to follow in determining whether a lease should be capitalized (included on the balance sheet) or expensed.

This term came into popular use during the Enron bankruptcy. Many of the energy traders' problems stemmed from setting up inappropriate off-balance-sheet entities.

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