Off-Balance Sheet Treatment – Solutions (Pros & Cons)
What is the off-balance sheet treatment?
To improve certain financial KPIs of a company, the off-balance sheet treatment keeps certain assets, liabilities or transactions out of the financial statement. This practice optimises financial metrics and enhances credit ratings.
Off Balance Sheet Solutions
Diving into off-balance sheet solutions reveals varied strategies like Pay-per-Use Financing, Special Purpose Vehicle (SPV), Sale and Lease Back or also Synthetic Leases. Each offers unique benefits and challenges for managing assets and liabilities creatively, but not all of them offers an off-balance sheet solution under IFRS 16. We'll explore these options to understand their impact on financial metrics and strategic alignment, guiding companies toward more informed decision-making.
Strategic Solutions:
1. Pay-per-Use Financing
With Pay-per-Use financing, you only pay for the actual usage of the asset. It transforms CAPEX to OPEX and unlocks the off-balance sheet treatment under IFRS16. This reduces hurdles to investment and enhances KPIs like free cash flow and Total Cost of Ownership (TCO).
Pros:
+ IFRS16 off-balance sheet treatment is confirmed by big four accounting firms.
+ Pay only when the asset is used.
Cons:
- Less control over the asset.
2. Special Purpose Vehicle (SPV)
Special Purpose Vehicle is a separate legal entity created to own the asset, thereby keeping the asset and its associated financing off the company's main balance sheet.
Pros:
+ Risk isolation as it separates the financial risks associated with the asset away from the company’s main balance sheet.
Cons:
- Long/complex structuring of the entity.
- Possible on the balance sheet of the group holding company under IFRS 16 (depending on the structure).
3. Sale and Lease Back
Involves a company selling an asset to a financier and then leasing it back, allowing the company to still use the asset even though it is accounted Off-balance sheet.
Pros:
+ Immediate cash from asset sales with retained usage rights.
Cons:
- Creates long term lease obligations.
- Less control and dependency on lease terms.
- On balance sheet under IFRS 16
4. Synthetic Leases
Structuring a lease to meet specific criteria so that it's treated as a rental expense, not a capital expense, keeping the asset Off-balance sheet.
Pros:
+ Potential tax advantages as payments are often deductible as OPEX.
Cons:
- High complexity and can carry large legal, financial and market risks.
Pay-per-Use Financing in Detail
What is Pay-per-Use Financing?
The key difference between traditional leasing and Pay-per-Use financing is that with Pay-per-Use, you only pay for the actual usage of the asset. In accounting terms, you transform CAPEX into OPEX and match costs to revenues. This way, Off-balance sheet benefits are activated.
What are benefits besides accounting assets off-balance sheet for equipment operators?
Pay-per-Use brings flexibility for operators as the asset’s utilisation risk is getting minimized without penalties or hidden costs in case of lower usage. Furthermore, Pay-per-Use is valued for its sustainable financing approach which supports the circular economy.
What benefits do equipment manufacturers have?
With Pay-per-Use, manufacturers meet current customer demands for adaptable payment options. It also allows for higher earnings by incorporating long-term service contracts and spare part provisions, extending revenue streams beyond the initial sale.
Conclusion
There is more then one way to finance assets off-balance sheet and it depends heavily on company’s resources and risk tolerance. If it is Pay-per-Use Financing, Special Purpose Vehicle (SPV), Sale and Lease Back or Synthetic Leases, each method offers its unique blend of pros and cons. Ultimately, the choice of an Off-balance sheet option should be guided by a company's specific circumstances, balancing the need for financial flexibility with the risks and responsibilities each option entails.
