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OFF Balance Sheet Financing | Definition | How Does it Work? - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell ican Friends today we going to learn a concept which is
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off-balance-sheet financing what exactly
this is all about I will show you one in
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extract over here the table the
following table summarizes of a
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contractual obligation of borrowing and
the timing and the effect of such
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commitments are expected to have on our
liquidity and the capital required in
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the future period as you can see over
here the operating lease payment or the
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operating lease obligation which is the
off-balance sheet financing less than
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1 year 1 to 3 years okay
no issues let's understand this in a
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detail format or what exactly this is
all about see off-balance sheet
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financing is basically lie aur liability with the first in the foremost that is not
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directly recorded on the balance sheet
of the company the off-balance sheet
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financing items you know they carry
enough significance because even if they
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are not recorded on the balance sheet
finance they are still the liabilities
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and should be included in the overall
analysis of the fin position or the
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financial position of the company now
how does the off-balance sheet financing
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exactly work let's say suppose ABC
manufacturers limited is the is and
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undergoing expansion plan and wants to
purchase machinery to establish the
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second unit in another state however it
does not having a financing arrangement
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let's say for the same and it and as its
balance sheet is already heavily
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financed in such a case you know it has
two options it can set up JV or we call
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as a joint venture with the other
investor or the company to establish a
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new unit and obtain a fresh financing
name of the new entity on the other hand
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it can also check out the long the
long term lease agreement with the
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equipment manufacturing for the leasing
of machinery and in in this case it
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needs to worry about the obtaining the
fresh financing both of the above cases are
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example of the off-balance-sheet
financing now what is the purpose what
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is the purpose of balance sheet items of
balance sheet at first to maintain the
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solvency ratio like a debt to equity
ratio below a certain
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and obtain funding which a company would
not have been able to obtain otherwise
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second it will be better of solvency
better solvency ratios ensure
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maintaining a good credit rating which
in terms allows you know the computer
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access cheaper finance third it makes
balance sheet finance appear a linear
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which a prime facie may attract the
investors now there are some key
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features of off-balance sheet financing
first it results in the reduction or
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what we see is reduction in the existing
assets exclusion basically you can say
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that of the assets going to create to be
created in the balance sheet second
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there is a change in the Cap structure
of the company third the assets and the
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liabilities are both under state under
stated and it gives a linear approach or
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impression of the balance sheet finance
okay let's discuss the off-balance sheet
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items the first and foremost item that
we need to discuss in our list is
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leasing well it is the oldest form of
the off-balance sheet financing leasing
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is an asset that allows the company to
avoid are showing financing of the asset
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from its liability and lease or rent is
directly shown as an expense in the
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profit and loss account so first of that
we have for the lease it is the source
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of the off-balance sheet financing as
lessor basically where's the the
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financing of the asset and second you
can see that the conventional method to
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acquire the asset which requires a large
capital outlay third it makes easier to
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upgrade technology with the changing
times fourth it makes easier it makes
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easier for for only the operating leases
because they qualify as the off-balance
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sheet financing and the financing leases
are required to be capitalized on the
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balance sheet as per the latest India's
second the SPV which is known as your
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special purpose vehicle that's the
special purpose vehicles are the
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subsidiary companies are one of the
routine ways of creating the balance
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sheet financing this way are you
this this was the way that was used by
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Erron which is known as one of the
high-profile off-balance-sheet financing
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exposure controversy the first point on
that is you know the parent company
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creates the SPV to enter into the new
set of activities but wants to isolate
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itself from the risk and liabilities
from the new activities second the
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parent company needs to show the asset
and the liability of the SPV on its
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balance sheet third the SPV acts as an
independent entity and acquires its own
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credit lines for the new business fourth
if the parent company fully owns the SPV
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and under the accounting standards for
most countries it needs to we
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consolidated with the SPV balance sheet
into its own which defeats the purpose
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for creating the off-balance sheet
finance and therefore normally companies
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create SPV by way of new JV which is
called as the joint ventures with cement
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the third example for the off-balance
sheet financing is the HP that is the
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higher Purchase Agreements you know if a company cannot afford to purchase an
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assets outright or to obtain finance for
the same it can enter into the HP at the
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hara hire purchase finance agreement for
certain period differences which will
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purchase the assets for the company
which in turn will pay the fixed amount
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monthly until all the terms in the
contract are fulfilled now the hirer has
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an option of owning the asset at the end
of the higher purchase agreement under
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the normally accounting the acid reflux
in the balance sheet of the purchaser
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and hirer
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needs not show it in its balance sheet
during the period of the airport
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purchase contract gets a balance sheet
of it gets a benefit the off-balance
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sheet financing fourth fourth is
factoring now it is a type of the credit
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services offered by the banks and other
financial institution to their existing
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clients under the factoring financing is
obtained by selling account receivables
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to the banks selling account receivables
to banks and banks offer immediate cash
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to the company after taking some cut
from the accountable receivables for offered
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bringing these services it is also
termed as the accelerating of cash flows
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and Third Point on this no there is no
direct liability on the company due to
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the factoring but there is a sale of
some of the assets right so what exactly
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is the significance this for the
investor see the significance is quite
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clear here that you know under the
accounting standards for almost all the
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major countries it is mandatory it is
mandatory to make full disclosure of all
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the off-balance sheet financing items
for the company for the particular year
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so investors should take a note of this
and the disclosure to be fully
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understand to fully understand the risk
associated with such so that's it know
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for now for the off-balance sheet
financing so that's it
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for this particular topic if you have
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