Asset Based Financing

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

creditors are worried there might be another strike which would fully

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

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

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

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

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

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

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

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

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

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

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

that one so from an accounting perspective there

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

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

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

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

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

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

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

six hundred thousand dollars worth of financial commitment or obligation paid

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

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

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

and in practice conservative companies actually put a line for lease

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

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

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

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

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

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

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

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

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

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

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

unquote well how did they pull off this magic

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

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

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

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

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

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

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

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

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

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

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

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

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

orchestrating the whole Enron dance