Most business owners minimize taxable income by eliminating expenses that are not directly related to the business’s operations. These expenses might cover personal auto, insurance, cellphone, child care, medical care, travel, among others. For this reason, adjusting the financial statements by “adding back” these expenses is often necessary to show potential owners the actual cash flow available.
Adjusting the financials allows us to compare your business to other businesses using seller’s discretionary earnings (SDE), also referred to as seller’s discretionary cash flow (SDCF), adjusted cash flow, owner benefit, recast earnings or normalized earnings.
Among all these terms, SDE is the most common metric used by business brokers and many other professionals, including buyers.Seller’s Discretionary Earnings or SDE is defined by the International Business Broker’s Association (IBBA) as:
Pre-tax net income (the bottom line profit that appears on profit and loss statements); plus
Owner’s compensation paid to all owners, less the cost needed to replace a second or third owner; plus
Interest expense; plus
Depreciation and amortization; plus
Discretionary expenses (auto, cellphone, meals, entertainment, travel, etc.); plus
Adjustments for extraordinary , non-operating revenue or expenses , non-recurring expenses or revenue (lawsuit, flood damage, etc.)
Pre-Tax Net Income