How much room is left, and who decides
Most reports end up producing some version of a headroom number: how much more a merchant could plausibly carry. It is the figure people reach for first, and it is one line of arithmetic resting on one convention that somebody chose. Both halves of that are worth saying out loud, because a number with an opinion buried inside it is more dangerous than an opinion stated plainly.
- One multiplication, one subtraction, one convention
- Shown in the report, never allowed into the risk score
- Floors at zero, because negative room is just burden restated
What it is, in one sentence
Take trade revenue — what the business earned, with financing proceeds and internal movements stripped out. Take a prudential share of it: half. Subtract everything already going out as debt service. What is left is the headroom figure, floored at zero.
That is the whole computation, and it is deliberately the whole computation. Every input is visible elsewhere in the report, so nothing about the result is hidden in a model: if you disagree with the answer, you can see exactly which of the three numbers you disagree with.
Where the half comes from
Nothing in nature says a business can commit half its revenue to financing and no more. The line is a prudential convention, and funders hold it at different places — tighter for thin-margin trades, looser where gross margins are high and receipts are daily. Reasonable people set it differently for good reasons.
We publish one line rather than none, because a figure computed the same way on every file is comparable across files, and a figure that moves with whoever is reading is not. And we publish the inputs beside it, because your line is one multiplication away: if you underwrite to 40%, the revenue figure is right there to multiply.
It is shown, and it does not vote
The headroom figure is never allowed to feed the risk score. That is a deliberate wall, and the reason is the convention above.
If headroom fed the score, and the score coloured the decision, then a policy choice — that half of revenue is the right line — would be riding inside a number that presents as an observation. The underwriter would be applying our threshold while believing they were reading their file. A figure derived from a judgement should be labelled as such and left where it can be argued with, not laundered into a score.
This is the same rule that governs the rest of the report: say what the evidence supports, name the assumptions, and leave the decision where it belongs.
Four things the figure does not know
None of these are flaws in the arithmetic. They are the questions that remain after the arithmetic is done.
What the next advance actually costs
Headroom is a monthly amount. A deal is a daily debit for a number of months at a factor rate. Whether a given offer fits inside the room depends on the shape of that offer, and the report has never seen the term sheet.
What next month looks like
The figure describes a period that has already happened. A seasonal business at the top of its season has headroom that will not be there in eleven weeks, and the statement in front of you states that fact in a tone of complete confidence.
Everything that is not debt service
Rent, payroll, tax, stock, the owner’s drawings. A merchant can show comfortable headroom against financing and have nothing at all after the obligations that keep the doors open. Headroom is room against debt, not room in the business.
What never touched the account
An advance repaid out of card settlement takes its share before the money arrives, so it is absent from the debt-service total and quietly inflates the room. That is why a split-funded position is estimated and shown separately rather than left to distort a figure that looks precise.
Why the figure stops at nothing
When debt service already exceeds the line, headroom reads zero rather than a negative amount. A negative room figure is not extra information; it is the burden percentage restated in dollars, and it invites a reading it does not deserve — that being $4,000 “over” is a small problem and $40,000 over is a big one, when in fact both say the same thing: this merchant is past the line, and the question is no longer how much more they can take.
For the same reason, headroom disappears whenever the ratios do. It is a ratio wearing a currency symbol, and it inherits every condition that makes a ratio unpublishable: a period too short, a revenue base too small, totals that do not reconcile, an account funded by wages rather than trade.
What the number is good for
As a sort, it is excellent. Across a morning’s submissions it separates the files where the question is how much from the files where the question is whether at all, in one column, consistently, without anybody having to do arithmetic twice.
As a conversation, it is better still. “There is about this much room at our usual line, and it assumes next month looks like last month — does it?” is a question a merchant can answer, and their answer is frequently the most valuable thing in the file. What the figure is not is the end of the enquiry, and no report that prints it should pretend otherwise.
Common questions
What is the safe ceiling or headroom figure?
Trade revenue multiplied by a prudential share — half — minus what the merchant already pays in debt service, floored at zero. It estimates how much more monthly obligation the cash flow could carry at that line.
Where does the 50% line come from?
It is a convention, not a rule. Funders hold the line at different places depending on trade and margin. One consistent line is published so files are comparable, with the inputs shown beside it so a different threshold is one multiplication away.
Does headroom affect the risk score?
No, deliberately. The figure rests on a policy choice about where the line sits, and a policy choice must not ride inside a number that presents as an observation. It is displayed for the underwriter and excluded from the score.
Why does headroom show zero instead of a negative number?
Because negative room adds nothing the burden percentage does not already say, and invites the false reading that being slightly over is a different kind of situation from being far over. Past the line, the question changes.
Why is headroom missing on some reports?
It is a ratio expressed in money, so it is withheld under the same conditions as the other ratios: too short a period, too small a revenue base, totals that do not reconcile, or an account whose inflows are wages rather than trade.
Related
See the room, and the three numbers behind it
Upload a statement and read headroom next to the revenue and obligations it comes from.