Seller’s Discretionary Earnings (SDE) is a measure of a business’s financial performance, particularly useful for small businesses. It represents the total cash flow available to an owner-operator. Here’s how to calculate it:

Steps to Calculate SDE:

1. Start with Net Income: Begin with the business’s net income from its income statement.

2. Add Back Owner’s Salary: Include the owner’s salary and any benefits. This reflects the cash flow available to a new owner.

3. Add Back Non-Recurring Expenses: Include any one-time expenses that aren’t expected to recur in the future. These could include costs for legal fees, repairs, or other unusual expenditures.

4. Add Back Depreciation and Amortization: These are non-cash expenses that reduce net income but do not affect cash flow.

5. Adjust for Interest Expenses: If the business has debt, you may want to add back interest expenses to get a clearer picture of cash flow.

6. Consider Other Discretionary Expenses: Add back any personal expenses that the owner may have included in the business’s expenses (e.g., personal travel).

The formula can be summarized as:

SDE = Net Income + Owner’s Salary + Non-Recurring Expenses + Depreciation + Amortization + Interest + Other Discretionary Expenses

Example Calculation

Net Income: $100,000

Owner’s Salary: $50,000

Non-Recurring Expenses: $10,000

Depreciation: $5,000

Interest Expense: $2,000

Other Discretionary Expenses: $3,000

Using the formula

SDE = 100,000 + 50,000 + 10,000 + 5,000 + 2,000 + 3,000 = 170,000

Conclusion

The calculated SDE helps potential buyers understand the earnings potential of a business, making it a key figure in business valuation and sale negotiations.