54 Energy Project Financing: Resources and Strategies for Success
vate sector, one of the most frequently asked questions is, “How do we
keep this financing off our balance sheet?” and thereby not reflect the
transaction on the company’s financial statements as a liability or debt.
The reasons for this request vary by organization and include: (a) treating
the repayment of the obligation as an operating expense, thereby avoid-
ing the entire capital budget process, and, (b) avoiding the need for com-
pliance with restrictive covenants that are frequently imposed by exist-
ing lenders, which may be viewed as cumbersome to a point of interfer-
ing with the ongoing management of the company. Restrictive covenants
start by requiring the borrower to periodically provide financial state-
ments that enable the lender to track the performance of the company by
calculating key financial ratios measuring liquidity (i.e., the current ratio,
which is current assets versus current liabilities), leverage (debt-to-equi-
ty), and profitability margins. Covenants include maintaining financial
ratios at agreed standards. If the ratios are not in compliance with these
targets, the lender can call in all loans, creating serious cash flow prob-
lems for the borrower. Many of these financial ratios are improved by
keeping debt off the balance sheet. Other typical covenants include limi-
tations on issuing new debt, paying dividends to stockholders, and sell-
ing assets of the company.
While organizations in the public sector may not have to deal with
the profitability and equity issues of the private sector, they do face their
own challenges when incurring debt through the capital budget process,
which is established by statute, constitution, or charter, and usually re-
quires voter approval. Public sector organizations may find that the polit-
ical consequences of incurring new debt may be more of a deterrent than
the financial ones, particularly when raising taxes is involved.
Treating repayment of the financing for energy efficiency projects as
an operating expense can keep the financing “off the balance sheet.” And,
because the immediate benefit of installing energy efficiency projects is
reducing the operating expense budget earmarked for paying the energy
and water bills, off balance sheet treatment makes sense. Post-ENRON,
however, having your auditors treat financing as “off balance sheet” is
becoming increasingly difficult, especially in light of The Sarbanes-Oxley
Act of 2002, which established new or enhanced standards for all U.S.
public company boards, management, and public accounting firms.*Note, however, off balance sheet transactions will be referenced in the footnotes to the
organization’s financial statements.