Off-Balance-Sheet-Financing is associated with debt that is not reported on a company's balance sheet. For example, financial institutions offer asset management or brokerage services, and the assets managed through those services are typically owned by the individual clients directly or by trusts. While these financial institutions may benefit from servicing these assets, they do not have any direct claim on them.
The formal accounting distinctions between on and off-balance sheet items can be complicated and are subject to some level of management judgment. However, the primary distinction between on and off-balance sheet items is whether or not the company owns, or is legally responsible for the debt. Furthermore, uncertain assets or liabilities are subject to being classified as "probable", "measurable" and "meaningful".
An example of off-balance-sheet financing is an unconsolidated subsidiary. A parent company may not be required to consolidate a subsidiary into its financial statements for reporting purposes; however the parent company may be obligated to pay the unconsolidated subsidiaries liabilities.
Another example of off-balance-sheet financing is an operating lease, which are typically entered into in order to use equipment on a short-term basis relative to the overall useful life of the asset. An operating lease does not transfer any of the rewards or risks of ownership, and as a result are not reported on the balance sheet of the lessee. A liability is not recognized on the lessee's balance sheet even though the lessee has the obligation to pay an agreed upon amount in the future.
It is important to consider these off-balance-sheet-financing arrangements because they have an immediate impact on a company's overall financial health. For example, if a company defaults on the rental payments required by an operating lease, the lessor could repossess the assets or take legal action, either of which could be detrimental to the success of the company.
Jeffrey Skilling
Jeffrey Skilling is the former CEO of Enron, which was notorious for it's use of off-balance-sheet-financing.