The Numbers

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Let me start out by saying that I am not a CPA.  This information is to raise questions that you need to ask your CPA and decide what the best business decision for you is.

Let’s put some numbers out there to illustrate the benefits of off-balance-sheet financing, assume the following simplified balance sheet for the XYZ Co.:
Current Assets                  $1,000,000
Long-term assets              $7,000,000
Total assets                       $8,000,000
                

Current Liabilities                $   500,000
Long-term liabilities             $3,500,000
Owners’ equity                    $4,000,000
Total liabilities and equity    $8,000,000

XYZ has a current ratio (Current assets / Current liabilities) of 2:1 and a total liability to equity ratio (Total liabilities / Total equity) of 1:1.  Assume that XYZ wants to acquire additional battery testing equipment, VLF Hipots, Doble power factor test sets, Vanguard test sets and circuit breaker timers.  For simplicity sake we are going to say that all of this equipment adds up for simplicity sake $2,000,000.  One option is that XYZ can purchase these assets by making a $200,000 down payment, signing a ten-year note to borrow the remaining 90% from a bank, with interest and a $100,000 principal due next year.  Alternately, XYZ can use a lease to qualify for off-balance sheet financing.  The lease terms are that XYZ can sign a ten-year lease, the present value of which is $2,000,000, with no down payment required.  The balance sheets after acquiring the additional long-term assets under the alternative choices would be

                                                 Purchase         Lease
Current assets                         $800,000         $1,000,000
Long-term assets                     $9,000,000      $7,000,000
Total Assets                             $9,800,000       $8,000,000
            
Current liabilities                      $600,000          $500,000
Long-term liabilities                  $5,200,000       $3,500,000
Owners’ equity                         $4,000,000       $4,000,000
Total liabilities and equity         $9,800,000       $8,000,000
 
If XYZ borrows from the bank, the current ratio is lowered from 2:1 to 1.33:1 ($800,000 / $600,000), and the debt to equity ratio is increased from 1:1 TO 1.45:1 ($5,800,000 / $4,000,000).  However, if XYZ leases the assets, the ratios remain unchanged.  This example illustrates why off-balance-sheet financing, particularly through the use of leasing, is so attractive to most managers. The lease obligations are not capitalized, and consequently, debt ratios are not adversely affected.