One of the first phrases Business Buyers and Sellers run across are SDE and the second is likely Cash Flow.
SDE stands for Seller’s Discretional Earnings and Cash Flow in the world of business sales is essentially another way to describe SDE. This is often the most important metric for purchasing a business with borrowed funds.
Earnings from businesses come in two forms. One is the taxable income that is reported on tax forms and the other is seller’s discretionary earnings.
Tax returns include deduction for typical non-cash items such as depreciation and amortization, yet they reduce the net taxable income. There are also other entries that can reduce the net taxable income that have no bearing on cash available to run the business.
One of the most important items in determining any business value and the likelihood of securing funding is the SDE. One way to think of the SDE is that it is the cash available for debt service and owner compensation. You basically start with the reported taxable income and then add back the following; owner salary, benefits, perks, non-recurring expenses, expenses the new owner should not incur, personal expenses such as auto, medical, life insurance, retirement programs, cell phone, etc. Many owners get very creative in this area. If they are too creative, this can be problematic. We also add back any interest paid on money borrowed as the business will be sold debt free (debts paid at closing in most cases).
The process for determining the SDE is called recasting the financials or normalizing the financials. It is an accepted practice to accountants, appraisers and lenders as long as a business owner is not over creative.
I met a client the other day that had picked up some information on the internet and in general conversation with other business owners wile his was trying to determine what his business was worth. He came up with 2-3 x’s cash flow. His definition of cash flow was how much cash flowed through the company. In other words, sales. Needless to say he was disappointed after our initial conversation.
If you are interested in knowing more about the market value of your business, contact AEGIS Business Valuations 479.689.4455 Ext 11
About the Author: Richard Roberts is the Managing Broker at AEGIS Business Brokers, LLC
He is an active member of the IBBA International Business Brokers Association where he holds their top rating of CBI Certified Business Intermediary and the ABBA American Business Broker Association where he received his ABI Accredited Business Intermediary & SVA Senior Valuation Analyst Certifications.
You can reach Richard at firstname.lastname@example.org or 479.689.4455 Ext 11