Once customers have paid up, the factor pays the company the balance due minus a fee for services rendered.
In this way, a business can collect what is owed while outsourcing the risk of default.
The company leasing the asset only accounts for the monthly rental payments and other fees associated with the rental rather than listing the asset and corresponding liability on its own balance sheet.
At the end of the lease term, the lessee generally has the opportunity to purchase the asset at a drastically reduced price.
However, companies also use off-balance-sheet financing to preserve borrowing capacity (for example, when a company is close to hitting its limit on a borrowing line or would like to use its borrowing line for something else), lower their borrowing rates, or manage risk.
The strategy, however, has had a bad reputation since it was famously used by former energy giant Enron.
Companies must follow Securities and Exchange Commission (SEC) and generally accepted accounting principles (GAAP) requirements by disclosing off-balance sheet financing (OBSF) in the notes of its financial statements.
Investors can study these notes and use them to decipher the depth of potential financial issues, although as the Enron case showed, this is not always as straightforward as it seems.
Therefore, Company XYZ needs to find another way to obtain a the machine.
To solve the problem, Company XYZ creates a separate entity that will purchase the equipment and then lease it to Company XYZ via an , joint ventures, or research and development activities.