Off-balance sheet (OBS) refers to assets or liabilities that do not appear on the balance sheet of the company. Although OBS method of accounting can be used in several scenarios, this practice of accounting is especially useful for concealing the company’s financial statements, the impact of ownership of the asset and the associated liability.
Large asset purchases are often financed with the assistance of credit but too much debt can make the company less desirable to investors and creditors. The use of off-balance-sheet way for these types of assets can help businesses to maintain an attractive coefficients.
Some of the most common OBS assets represent operating leases, lease agreements and receivables.
OBS operating lease in which the lessor retains lease on its balance sheet. The company leasing the asset is only the monthly lease payments and other payments associated with the lease and not list the asset and the associated liability on its balance sheet.
At the end of the lease term, the lessee usually has the option to purchase the asset at a greatly reduced price.
Under the lease agreement, the company may sell the asset, for example, the subject property, to another entity. They can then rent the same property from the new owner.
As an operating lease, the company lists only the rental costs on its balance sheet, while the asset itself is listed on the balance sheet of the business owner.
Accounts receivable (AR) represents a significant liability for many companies. This category of assets reserved for funds that have not yet been received from the clients, so that the probability of default is high.
Instead of listing these risky assets on its balance sheet, the company can actually sell this asset to another company, called a factor, which then becomes the risk associated with the asset. The factor pays the company a percentage of the total cost of the RD in advance and takes care of the collection. Once the customer has paid, the factor pays the company the balance owed minus the fee for services rendered. Thus, the business can collect what is owed in case of outsourcing the risk of default.