The balance sheet looked light, but the business was not. Leverage ratios were comfortable and borrowings were modest, yet a closer review found long lease commitments, receivables sold with recourse, supplier finance lines and side agreements with customers. Individually manageable, together they changed the risk profile completely. Off-balance sheet items do not distort the numbers so much as bypass them. This article explains the main types diligence teams look for, where to find them, and how to bring them into net debt and price.
Off-balance sheet items are obligations or exposures that are not fully reflected as liabilities in the balance sheet, such as operating leases under AS 19, receivables discounted with recourse, supplier finance, purchase commitments, side agreements, and costs or assets held by promoter entities. Due diligence identifies them through contracts, bank records and minutes, and treats the material ones as debt-like items or price adjustments.
Why do off-balance sheet items matter in a deal?
Most acquisitions are priced on an enterprise value, from which net debt is deducted to arrive at the equity price. Anything that behaves like debt but is not recorded as borrowings will, if missed, be paid for twice: once in the price and again when the obligation falls due.
Off-balance sheet items also distort the ratios that lenders and investors rely on. A company can report low leverage while carrying significant fixed commitments, which reduces its ability to absorb a downturn.
The aim of diligence is not to criticise accounting choices, which may be fully compliant. It is to make sure the buyer sees every material commitment, wherever it is recorded.
The main off-balance sheet items to look for
Leases under AS 19 and Ind AS 116 exemptions
Companies applying Ind AS recognise most leases as right-of-use assets and lease liabilities under Ind AS 116, with exemptions for short-term leases of twelve months or less and leases of low-value assets. Companies that follow the Accounting Standards, including many unlisted SMEs, still apply AS 19, under which operating leases are charged as rent and future commitments appear only in the notes. A factory or warehouse on a long lease with fixed escalations is a long-term obligation either way.
Receivables discounted or factored with recourse
If the company sells or discounts receivables but remains liable if the customer does not pay, the financing is economically a borrowing. Under Ind AS 109, receivables are derecognised only if substantially all risks and rewards transfer. Under the Accounting Standards, bills discounted are commonly disclosed as a contingent liability rather than as debt.
Supplier finance and reverse factoring
Where a bank pays suppliers and the company repays the bank later, the liability may still be shown as trade payables. Amendments to Ind AS 7 notified on 13 August 2025 require entities to disclose the terms, carrying amounts and payment-date ranges of supplier finance arrangements. For diligence, the question is how much of 'trade payables' is effectively bank funding.
Purchase and capital commitments
Take-or-pay contracts, minimum purchase obligations and contracted capital expenditure commit future cash. Schedule III requires disclosure of commitments, but the operational significance often needs to be explained from the contracts.
Side agreements with customers and distributors
Volume rebates, buy-back promises, price protection and extended return rights may sit in letters or emails rather than the main contract. They can reduce revenue or create liabilities that the accounts do not reflect.
Costs and assets held outside the company
Premises owned by the promoter, staff on a group company's payroll, or vehicles and machinery in a related party's name may support the business without appearing in its accounts. After a sale, these will either need to be paid for or transferred. Our article on related party transactions in due diligence covers how to test such arrangements.
Unfunded employee obligations
Gratuity and leave encashment liabilities that are not actuarially valued or not funded can be understated, particularly in smaller companies.
Where diligence teams find off-balance sheet exposures
Include a specific warranty in the deal documents that all leases, financing arrangements, guarantees and material commitments have been disclosed. It will not find anything by itself, but it shifts the risk of non-disclosure back to the seller.
How off-balance sheet items are treated in net debt and price
Once identified, each item needs a deal treatment. The table below shows common approaches; the right answer depends on the facts and on consistency with how EBITDA is measured.
| Item | Typical treatment | Consistency point |
|---|---|---|
| Lease commitments (AS 19) | Present value may be treated as debt-like, or rent kept in EBITDA | Do not deduct the lease liability and also keep rent in EBITDA |
| Receivables factored with recourse | Added to net debt; receivables added back to working capital | Adjust the working capital peg on the same basis |
| Supplier finance | Amounts beyond normal credit terms treated as debt-like | Exclude from the normal level of trade payables |
| Customer rebates and buy-backs | Accrued as liabilities; revenue normalised | Reflect in adjusted EBITDA |
| Unfunded employee benefits | Actuarial deficit treated as debt-like | Use a current actuarial valuation |
| Promoter-provided assets and staff | Market cost added to EBITDA, or asset transfer as a condition | Avoid paying for earnings that depend on free support |
Working capital and net debt adjustments interact closely. See our articles on the working capital peg and EBITDA normalisation for how these adjustments fit together.
Illustrative example: when low leverage is not low leverage
A company following the Accounting Standards reports borrowings of Rs 10 crore and EBITDA of Rs 25 crore, a leverage ratio of 0.4x. Diligence identifies:
- Present value of remaining factory and warehouse lease payments: Rs 18 crore (annual rent Rs 4 crore)
- Receivables discounted with recourse: Rs 12 crore
- Supplier finance amounts beyond normal credit terms: Rs 8 crore
- Unfunded gratuity liability: Rs 3 crore
Total debt and debt-like items are Rs 51 crore (Rs 10 + 18 + 12 + 8 + 3 crore). Treating leases as debt means adding back rent, so lease-adjusted EBITDA is Rs 29 crore.
Adjusted leverage is about 1.8x (Rs 51 crore divided by Rs 29 crore), not 0.4x. Whatever multiple is applied, the equity value falls by every rupee of debt-like items not already reflected, and the business has far less headroom to borrow for growth than its balance sheet suggested.
Checklist for an off-balance sheet review
- List every financing relationship. Obtain bank confirmations for all facilities, including discounting, factoring, supplier finance and non-fund limits.
- Read every material contract. Leases, supply, distribution and customer agreements, including side letters and amendments.
- Trace expenses to agreements. Rent, hire, discounting charges, rebates and commissions should each link to a documented arrangement.
- Map related-party support. Identify assets, people and costs provided by promoter or group entities, and agree how they will be treated after the deal.
- Value long-term obligations. Discount lease and purchase commitments, and obtain actuarial valuations for employee benefits.
- Agree a consistent definition. Align net debt, working capital and adjusted EBITDA so that no item is counted twice or missed.
- Protect through documents. Use specific warranties, indemnities and, where needed, conditions precedent for items that cannot be fully quantified.
Comparing two targets where one applies Ind AS 116 and the other AS 19 can be misleading. The Ind AS company shows higher EBITDA and higher debt for the same leases. Put both on the same basis before comparing multiples or leverage.
Frequently asked questions
What are off-balance sheet items?
They are obligations or exposures not fully shown as liabilities on the balance sheet, such as operating lease commitments under AS 19, receivables sold with recourse, supplier finance, purchase commitments, side agreements and obligations borne through related parties.
Are leases still off-balance sheet in India?
For companies applying Ind AS 116, most leases are recognised on the balance sheet, apart from short-term and low-value leases. Companies following the Accounting Standards apply AS 19, under which operating leases remain off-balance sheet with commitments disclosed in the notes.
What are debt-like items in due diligence?
Debt-like items are obligations that are not recorded as borrowings but will require cash outflow, such as factored receivables with recourse, overdue statutory dues, unfunded employee benefits or deferred consideration. They are usually deducted from enterprise value along with net debt.
Is factoring with recourse treated as debt?
Economically, yes. Because the company remains liable if the customer does not pay, buyers generally treat the amount as debt and restore the receivables to working capital. Under Ind AS 109, such receivables are typically not derecognised.
What are supplier finance arrangements?
They are arrangements where a finance provider pays the company's suppliers and the company repays the provider later. Ind AS 7 amendments notified in August 2025 require disclosure of their terms, carrying amounts and payment-date ranges, which helps buyers see how much of trade payables is bank-funded.
How can buyers protect themselves from undisclosed commitments?
Through thorough contract and bank reviews, specific warranties that all financing and material commitments have been disclosed, indemnities for undisclosed obligations, and escrow or holdbacks where seller recovery is uncertain.
Conclusion
Financial statements show position, but agreements reveal exposure. Off-balance sheet items are often entirely legitimate and correctly accounted for, which is precisely why they are easy to overlook. A disciplined review of contracts, bank arrangements, related-party support and long-term commitments, followed by consistent treatment in net debt, working capital and EBITDA, ensures that a light-looking balance sheet is not mistaken for a lightly committed business.
Planning an acquisition or investment?
H K Davra & Co. carries out financial due diligence, quality of earnings and working capital reviews for buyers, investors and lenders.
Talk to usThis article is for general information only and does not constitute professional advice or solicitation. Examples and figures in this article are illustrative. Provisions are summarised as of October 2026. Please refer to the relevant provisions and seek advice on your specific facts.