What is SDE and Why is it Important?

By | August 4, 2017

SDE stands for Seller’s Discretionary Earnings and is also sometimes referred to as Cash Flow.

What it reflects is the actual cash that should be available to a new owner of a business for sale.

The Main Street Business arena is mostly filled with enterprising people that see being in business better than working for someone else.

That said, it is still a job or more accurately a replacement for a job. There are many advantages for some and also some challenges that if met can provide a good income.

The difference about a business versus a job is the way it is taxed……in order to balance things a bit, there are some expenses in a business that go against earnings in a effort to reduce tax liabilities. This is by design to foster small business growth. Most are legal and follow acceptable accounting practices but many are totally discretionary. In other words the seller can choose to incur the expenses or not and they won’t impact the business…..examples would be a conference in Hawaii versus one in Kansas City, charitable donations, medical insurance, retirement plans, interest, amortization, training, research trips, cell phones. Some people get extremely creative. I remember an accountant I had in the 70’s that always said when in doubt deduct…I’ve seen some people take this to a whole new level.

When we as business brokers are determining what the most likely market value for a business is, we perform what is called a re-casting of the the financials. That is we take the business tax form or schedule “C” and find items to add back to the bottom line to more closely reflect what cash could be available to a new owner.

The following are the most typical items we back out of expenses and add back to the bottom line either entirely or in part:

  • Interest Paid
  • Taxes – Income
  • Depreciation
  • Amortization
  • Officer’s Salary
  • Officer’s Payroll Taxes
  • Officer’s Portion of Pension
  • Owner’s Perk – Auto and Insurance for Life and Health, Travel, Etc
  • Telephone – Non-Business
  • Real Estate Expenses
  • Adjustment for market rent if rent low, high or non-existent
  • Non-Essential Payroll – (especially non-working family members)
  • Donations not connected to business
  • Due and Subscriptions not connected to business
  • Bad Debt if out of normal course of business
  • One Time non-recurring expenses
  • Major customer loss or gain
  • Lease that will be paid off at closing
  • Penalties

When you are evaluating a business for purchase it is a good idea to see the brokers recasting worksheet of the past three years of business. If you see large and/or unusual items listed, get clarification in writing and then see if it makes sense to you.

Richard Roberts, ABI is the Senior Managing Broker at AEGIS Business Brokers, LLC and holds an Accredited Business Intermediary classification by the American Business Brokers Association and is a member of the International Business Brokers Association, International Franchise Professionals Group, Chambers of Commerce, Committees and Volunteer Organizations. Contact Richard at 479.689.4455 or richard@aegis-email.com.

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