Leverage

Debt magnifies outcomes in both directions. It raises returns on equity when the business earns more than the debt costs, and it destroys the business faster when it does not. Underwriters measure it two ways.

• Debt to equity: total liabilities divided by tangible net worth. A balance-sheet view. Weak in small business because tangible net worth is often small, distorted by owner loans, or negative after years of distributions
• Debt to EBITDA: total debt divided by earnings before interest, tax, depreciation and amortisation. A cash-flow view, and the one most bank and SBA credit memos lead with

Adjustments that matter in small business

Owner loans to the company are sometimes reclassified as equity if formally subordinated. Owner compensation above or below market is normalised. Operating leases and any off-balance-sheet obligations are counted. And a business's real leverage frequently only becomes visible in the bank statements.

Merchant cash advances and leverage

Advances are not reported to the commercial credit bureaus, and because they are structured as purchases rather than loans they may not appear as debt on a balance sheet prepared without care. This leads owners to believe they are invisible. They are not. Every bank statement shows the funding deposit and the pattern of fixed daily debits that follows, and any competent underwriter reads the debits, counts the funders, and annualises the obligation. A file showing three sets of daily debits is a heavily leveraged file regardless of what the balance sheet says.