Talk to a salt of the earth Australian businessman about off-balance sheet financing, and he’s likely to look at you askance. Quite rightly, people want to do things by the book, especially when it comes to business financing. But that doesn’t necessarily mean on the books.
That’s because the practice of raising funds in a manner which stays off your balance sheet is entirely legitimate. Indeed, some accepted and long-established forms of business funding naturally sit off the balance sheet, because they don’t become a risk or a liability.
These include various forms of debtor finance, such as factoring and invoice discounting, and some asset financing arrangements such as operating leases and sale/leaseback financing.
Balance Sheet vs Off Balance Sheet Financing
If you take out a business loan – like an unsecured business loan or a bank loan secured against your own assets – you take on an ongoing liability to repay the amount. Therefore, the debt has to go on your balance sheet.
Generally speaking, there are limits to how much a business will be allowed to borrow in this way. These limits may be determined by a debt-to-equity ratio, which is effectively a calculation of a company’s borrowings compared to its expected income. Or finance companies may simply feel that they don’t wish to fund a business which already has a number of debts.
On the other hand, off balance sheet financing does not represent a liability to the recipient. The various forms of cash flow financing are a good example of this. Invoice discounting is a great way to improve cash flow and can even be used to inject major funds into a trading business. But it is not really debt at all. Invoice discounting is actually the sale of accounts receivable.
Cashflow financing reflects your business
When you sell some of your accounts receivable, the invoice financing company forwards you most of the cash. If it is a non-recourse transaction such as tim. offers, you don’t take on a liability. Instead, the money is collected when your client pays, at which point you actually get the remainder of the invoice amount, minus a small fee.
You can’t raise more money than you are legitimately owed in this way. That’s why it can remain off the balance sheet – each invoice discounting transaction is effectively already paid for.
There are many advantages to keeping your everyday cash flow funding off the balance sheet. For example, your accounts will look stronger to potential suppliers, customers and partners. And if you do need to raise a debt for an exciting expansion opportunity, it will be easier because you have a clean sheet to start with.
Off balance sheet financing can get a bit complicated when it comes to global conglomerates, and especially resource companies which have a number of legitimate but complex means of off balance sheet financing. Occasionally those processes have been abused, such as we saw with the Enron scandal.
Unfortunately, this has contributed to a reluctance by some smaller businesses to consider what may be the best forms of funding for them. Off balance sheet funding isn’t a dirty word. It’s a very useful tool for any small or medium sized Australian business.