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What is Seller's Discretionary Earnings (SDE)?

Seller's Discretionary Earnings, sometimes referred simply as “Cash Flow”, represents the total financial benefits accruing to the owner-operator of a business. In simpler terms, it's the amount of money a business owner can potentially take home in a year, including their salary, perks, and various discretionary expenses.

Why is SDE Important in Business Brokerage?

  1. Valuation Basis: Unlike larger corporations where earnings are strictly defined and separated from owner benefits, small to medium-sized businesses often intertwine personal and business expenses. SDE provides a more accurate picture of the business's profitability, serving as a basis for valuation.

  2. Evaluation Tool: For potential buyers, SDE helps evaluate the earning potential and feasibility of acquiring a business. It allows them to understand the true financial performance of the business and make informed decisions.

  3. Negotiation Parameter: During negotiations, SDE serves as a reference point for establishing the fair market value of a business. Both parties use it as a benchmark to reach mutually beneficial terms.

  4. Financing Consideration: Lenders often consider SDE when evaluating loan applications for business acquisitions. It provides insights into the business's ability to generate income and repay debts.

Calculating Seller's Discretionary Earnings

While the formula for calculating SDE may vary slightly depending on the business's specifics, it generally involves the following steps:

  1. Start with Net Profit: Begin with the business's net profit, which includes revenue minus all expenses except for owner benefits.

  2. Add Back Owner Benefits: Identify and add back any owner benefits or discretionary expenses, such as owner's salary, perks, personal expenses, and one-time expenses not essential for the business's operations.

  3. Adjust for Non-Recurring Items: Exclude any one-time or non-recurring expenses or revenues that are not expected to continue in the future.

  4. Normalize Expenses: Normalize expenses to reflect market rates. For example, if the owner pays themselves significantly below market salary, adjust it to a fair market rate.

  5. Calculate SDE: Sum up all the adjusted figures to arrive at the Seller's Discretionary Earnings.

Seller's Discretionary Earnings provide a holistic view of a business's financial performance by incorporating owner benefits and discretionary expenses. In the realm of business brokerage, understanding SDE is fundamental for accurate valuation, informed decision-making, and successful negotiations. Whether you're a buyer or a seller, being well-versed in SDE can greatly enhance your ability to navigate the complexities of business transactions and achieve favorable outcomes.

If you are interested in obtaining a valuation of your business, please contact me for a no-obligation, no-cost conversation. or 850-532-0075

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