A form of leverage that an entity can attain from an off-balance sheet item (asset, liability, financing activity, etc.) By not showing specific assets or liabilities on its balance sheet, an entity can keep its debt-to-equity ratio low or within acceptable or controllable limits (for reasons relating to financial stability, creditworthiness, regulatory requirements, etc.)
The most common types of this leverage include operating leases, project financing and other large capital expenditures (e.g., research and development):
- operating leases: an arrangement for leasing rather than purchasing an asset.
- project financing: borrowed funds that are used to finance an asset or project. After construction, the proceeds generated by the asset/ project will be used to repay the debt.
- large capital expenditures (CAPEX): for which a limited partnership with an investor can be forged. In which case, the risks will borne by the limited partnership and the related costs and debt will not appear on the balance sheet of the entity.
It is also referred to as incognito leverage, camouflaged leverage or off-balance sheet financing.
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