When buying or selling a business, understanding its financial health is critical to making informed decisions. One of the most important figures for both buyers and sellers is Seller's Discretionary Earnings (SDE). This metric provides a clear picture of the total earnings available to a new owner, offering an essential tool for evaluating the true profitability of a business. In this article, we'll break down the key components of the SDE Worksheet and explain how it helps you assess the potential earnings of a business.
Seller’s Discretionary Earnings (SDE) are used to determine how much a business generates for its owner. Unlike net income, SDE adjusts for personal expenses, one-time costs, and non-cash items, providing a more accurate reflection of a business's profitability under new ownership. This metric helps both sellers and buyers understand the financial viability of a business and make informed decisions.
The SDE Worksheet is a financial tool that breaks down the different elements affecting a business's profitability. Here are the main components:
The starting point for calculating SDE is Revenue, which represents the total income generated by the business. This is the money made from the sale of goods or services and serves as the foundation for assessing profitability.
Next, we subtract the Cost of Goods Sold (COGS), which are the direct costs tied to producing the goods or services sold. These costs include things like materials and labor directly involved in production.
After subtracting COGS from revenue, we arrive at the Gross Profit. This figure shows what’s left after the direct costs of production have been accounted for, which can then be used to cover operating expenses like rent, utilities, and salaries.
Operating expenses encompass all the costs associated with running the business, such as rent, salaries, insurance, and utilities. These are subtracted from the gross profit to determine the business's profitability before tax.
Once operating expenses are deducted from gross profits, we arrive at Net Income—the business’s profitability before accounting for any discretionary or non-operating adjustments. Net income reflects the business’s financial position under its current ownership.
To get the Basic SDE, we start with Net Income and adjust by adding back specific expenses that don’t reflect the true profitability of the business under new ownership. These adjustments include:
By making these adjustments, the SDE Worksheet provides a more accurate reflection of the business’s true earnings potential for a prospective buyer.
The SDE Worksheet is an invaluable tool for both sellers and buyers, offering a snapshot of the business’s earnings and allowing for a deeper understanding of profitability. For buyers, it ensures that they are making a sound investment based on the business’s true earning potential. For sellers, it provides a clear picture of the business’s value and helps in negotiating a fair sale price.
If you have questions about calculating SDE or need help assessing a business, don’t hesitate to reach out to us. Our team at Sharp Business Brokers is here to guide you through the process and help you make informed decisions about your business sale or acquisition.
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