For income, we attempt to calculate Seller’s Discretionary Earnings (SDE), which removes the effect of any tax or profit-taking strategies (such as salary or benefits) in order to compare companies.
SDE is directly tied to the value of an owner’s (your client’s) business.
• SDE is a standardized way of showing the potential profit for a buyer after selling.
• It represents the total pool of income available to a future owner.
Companies are most commonly valued as a multiple of income or profit. Your financial situation, profit-taking decisions, and taxation strategies can make a profit widely different from one business to another.
This is dependent on an owner’s financial situation and choices:
• Leveraging a lot of debt or making larger purchases
• Taxation strategy – When a business owner makes it within their best interest to minimize income on their financial statements
• Profit that varies for smaller businesses
• Benefits and perks, especially in smaller businesses
Profit entered in question 34 can mean different things for different business owners. It can mean any of the following:
• Pre-tax – What you report on in taxes
• EBITDA – Standard for large companies (higher than pre-tax)
• Gross profit or net income – Bottom of profit and loss statement; probably what you care about internally
• Other – We have heard some unique things brought up.
There is another way of expressing profit called Adjusted EBITDA, which only adjusts the owner’s salary for a market replacement instead of adding it back in. This is usually more appropriate for larger companies ($5 million+) and is therefore not currently used in this algorithm. We use the Income Adjustment Wizard to find this value. If the business owner chooses not to use the wizard, the algorithm will use the values entered in question 34 and assume that it is SDE.