What Is Seller’s Discretionary Earnings?
Note: A very solid effort at defining Seller’s Discretionary Earnings — probably the single most important thing to understand for most business owners.
What is Discretionary Cash Flow?
A seller’s discretionary earnings are the pretax and pre-interest profits before non-cash expenses, one owner’s benefits, one time investments, and any non-related income or expenses. In addition, SDI may require that expenses be adjusted if a new owner will necessarily need to take on a new expense.
Let’s break this down into each of its parts:
- Pretax and pre-interest profits before non-cash expenses. This is EBIDTA, the accounting terminology for earnings before interest, depreciation, taxes, and amortization.
- One owner’s benefit. Standard in the calculation of SDI is the “add-back” of one owner’s compensation. If there are multiple owners who actively participate in the operation of the business, part of the calculation of SDI requires that a projection be done to replace the other owner’s efforts and work.
- One-time expenses. This would include major website redesigns, acquisition of specific licenses, one time application fees, etc.
- None-related business expenses or income. Common scenarios would be taking consulting income and running that through your e-commerce business, taking extra time on a business trip for a personal vacation, charging your business “rent” for a home office, running an automobile expense through your business when your business does not require an automobile, etc.
- Adjusted expenses. Consider a company that owns a large fulfillment center and a small website they operate out of that same fulfillment center. Any company acquiring this small website will need to account for the expense of warehousing and filling orders. This expense will need to be injected into the overall earnings statement of the business.
Read the entire article at: https://www.quietlightbrokerage.com/resource/sellers-discretionary-income.