27 Oct The Small Business Owner’s Guide to Calculating SDE (Seller’s Discretionary Earnings)
Summary of This Guide
If you own a small or mid-sized business, your most important number is probably SDE, which stands for Seller’s Discretionary Earnings.
SDE is the primary figure that buyers and appraisers use to determine the actual value of your company. Why? Because SDE shows the true profit of your business before factoring in the unique ways you, as the owner, choose to operate, such as taking a salary or running personal expenses through the company.
This guide will walk you through SDE, show you the simple formula, explain which expenses you need to “add back,” and help you understand why this can make or break your sale price. Mastering SDE is the first step toward maximizing your business’s value.
What Is SDE and Why Does It Matter?
When someone considers buying your company, what they’re really buying is its cash flow. They need to know that the business can cover its expenses, pay its own salaries, and still generate a profit.
For large corporations, analysts often use EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). However, for small and mid-sized businesses, SDE is a more suitable measure.
SDE reflects the true benefit the current owner receives. As a small business owner, you wear multiple hats: general manager, salesperson, and financial planner. You may also run certain personal expenses through the business to save on taxes, which makes perfect sense during ownership but hides the company’s actual profit when it’s time to sell.
SDE normalizes that profit. It adjusts the numbers to show how much money would be left for a new owner to run the company and still earn a good income.
The Secret of “Add-Backs”: The Key to SDE
To calculate SDE, you start with your company’s Net Profit, then make adjustments by adding back expenses that are unique to you as the current owner. These adjustments are referred to as add-backs or income statement adjustments.
You add them back because the new owner will not have those specific costs, which means they’re not true business expenses moving forward. Adding them back creates a more accurate profit number and helps justify a higher asking price.
The goal is to normalize your cash flow, to present a clear and honest picture that supports your valuation and builds buyer confidence.
What Is an Add-Back? (4 Common Examples)
Most owners have these four types of add-backs. When calculating SDE, identify and separate them clearly:
1. Owner’s Salary and Benefits
This is usually the largest add-back. Since you’ll no longer draw a salary after selling, your pay and benefits are added back to profit. The new owner will decide their own compensation, but the company’s underlying cash flow remains constant.
2. Owner’s Personal Expenses
If your company pays for family cell phones, a personal vehicle, or a trip that was half business and half vacation, those are personal expenses. They should be added back because the next owner won’t have them.
3. One-Time or Non-Recurring Costs
If your business experienced a large, unusual expense, such as a legal settlement, emergency equipment repair, or one-off consulting fee, you can add that back. Since it’s not a recurring cost, it doesn’t accurately reflect the company’s ongoing performance.
4. Depreciation and Amortization
These are non-cash expenses. They appear on your financial statements, but no actual money leaves your bank account when they’re recorded. Because they’re accounting deductions rather than cash outflows, they’re added back when calculating SDE.
The Simple SDE Formula
SDE = Net Profit + Owner’s Salary/Wages + Owner’s Personal Expenses + Non-Recurring Expenses + Depreciation & Amortization
Once you have your SDE number, you can use it to estimate your company’s market value.
SDE in Action: Turning Profit Into Price
After calculating your SDE, valuation experts apply a multiplier to determine the estimated value of your business:
Business Value = SDE × Multiplier
The multiplier represents the level of risk or stability in your business. It’s at the heart of the Income-Based Approach to valuation.
What Drives the Multiplier?
- Higher Multiplier: Businesses that are growing, well-documented, and not dependent on a single customer are considered low-risk and receive higher multiples.
- Lower Multiplier: Businesses that rely heavily on the owner, have poor financial records, or are experiencing declining performance are considered high-risk and earn lower multiples.
By making sure your SDE is accurate and your business systems are strong, you increase both your SDE and your multiplier, leading to the highest possible sale price.
Your Homework: Getting Ready for a Sale
Your SDE calculation is only as strong as the supporting documents that back it up. If you’re planning to sell, begin organizing your financial records now.
Buyers will expect at least three years of historical financial statements, including income statements, balance sheets, and tax returns.
Why Clean Records Matter
- Credibility: Professional, organized SDE documentation builds trust and justifies your asking price. It shows you’re serious and prepared.
- Speed: Clean, audit-ready financials simplify due diligence—the process where buyers verify your numbers. This helps avoid lowball offers and shortens the time to closing.
Avoid the Biggest SDE Mistake: The Goodwill Misconception
A common mistake among business owners is misunderstanding Goodwill.
The Mistake
Many owners think Goodwill—your brand reputation, customer loyalty, and community relationships—is a separate amount of value that can be added on top of your calculated price.
The Reality
Goodwill is already included in your valuation. The SDE multiplier accounts for your reputation, systems, and customer trust. Trying to add Goodwill on top of your SDE-based valuation will make your price seem inflated, and buyers will push back.
Next Steps: Take Control of Your Value
Calculating your SDE is more than an accounting task; it’s the foundation of your exit strategy. It gives you a clear, objective measure of what you’ve built.
If your SDE is strong, you’re on the right path. If it’s lower than expected, now you know where to focus your improvements before you sell.
A qualified valuation expert can help you identify and defend every legitimate add-back, ensuring your SDE is accurate, defensible, and positioned to earn the highest possible sale price. Please don’t hesitate to contact us and speak with one of our experts to take control of your business value so you can exit on top and on your terms.