Off balance sheet financing is a financial obligation of a business that is not stated on its balance sheet. These arrangements are used when an entity wants to keep its leverage ratios as low as possible, possibly to avoid breaching a loan covenant that forbids a high degree of leverage. Also, by presenting a low debt level to lenders, borrowers can obtain a lower interest rate on their debt arrangements.
The use of off balance sheet financing is not encouraged, since it makes for obscure financial statements that do not reflect an entity's true condition. Investors may be surprised at a later date when the circumstances change or there are alterations to the accounting standards, resulting in the sudden appearance of large amounts of debt on an organization's balance sheet.
These arrangements frequently include special purpose entities, research partnerships, and joint ventures.