ShmoopTube

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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creditors are worried there might be another strike which would fully

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

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

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

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

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

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

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

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

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

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

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

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that one so from an accounting perspective there

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

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

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

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

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

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

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

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six hundred thousand dollars worth of financial commitment or obligation paid

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

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

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

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and in practice conservative companies actually put a line for lease

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

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

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

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

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

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

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

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

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

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

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

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unquote well how did they pull off this magic

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

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

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

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

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

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

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

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

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

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

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

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

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

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orchestrating the whole Enron dance

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