When it comes to selling a small business, there is a lot more to consider than just the net profit of the business. Since many small businesses are operated by their owner, they often work harder to maximize their cashflow itself. 
For example, they capitalize on the tax deductions found in salaries and benefits, which reduces the company’s net profit, but are still extremely beneficial to the business owner. As such, a better way to measure the earning power of a small business is with the Seller’s Discretionary Earnings, or the SDE.
Seller’s Discretionary Earnings Explained
Essentially, SDE allows companies to give a more realistic picture of what a small business is worth to the potential buyer. It accounts for the total financial benefit to the owner-operator, and it is usually used as a valuation tool for companies valued at less than one million dollars, in which the buyer will become the operator. It allows the seller to paint a lifestyle picture for the potential buyer, so they can really see what owning this business means for their personal finances.
How to Calculate the SDE
To compute the SDE—also referred to as the Adjusted Cash Flow, Normalized Earnings, Owner Benefit, and Owner’s Cash Flow—the past three years of tax returns, P&L statements, and other financial records will need to be obtained. Then, the following will need to be considered:
- How much cash was paid to the owner, including salary, profit sharing, etc.
- What portion of payroll taxes the employer is responsible for according to the W2 salary of the owner.
- How much net income the owner received pretax.
- How much interest was paid (debt is assumed to be paid off in a sale, so this expense shouldn’t be part of the equation).
- Any applicable depreciation and amortization.
- What discretionary expenses are involved. These are the extra benefits for the owner that are paid for by the business. This may include health insurance, travel costs, automobile costs, and other verifiable expenses that only benefit the owner and not the business or employees.
- Make sure any one-time, non-recurring expenses or income are not part of the equation, such as hefty expenses for flood damage or income from a product that is no longer part of the business.
Choose VR Business Sales New Haven for Your SDE Valuation
If you are selling a small business, and the potential buyer is going to take over as the operator, then computing an accurate SDE calculation is vital. Our business brokers in New Haven have over 10 years of experience in calculating accurate SDE valuations. We would love to help you compute your SDE so that you can present potential buyers with an accurate value that truly demonstrates what your company has to offer. To learn more, contact us now.