For business owners thinking about a future sale, understanding the basics of business valuation is a critical first step. One of the most important, and commonly referenced figures in small business transactions is Seller’s Discretionary Earnings (SDE).

SDE is a measure of the total financial benefit a single owner-operator derives from the business. It starts with net income and then any expenses that are personal, non-essential, or one-time in nature are added back. Since SDE is typically used for businesses where the new owner will also be the operator, the current owner’s wages are also added back. The result is a normalized figure that shows the true earning power of the business from the perspective of a potential buyer.

This is where the concept of add backs comes in. Add backs are adjustments made to the reported earnings to reflect the true, recurring earnings of the business. They might include personal travel, non-business-related meals and entertainment, or one-time legal or consulting fees. These are common examples, but certainly not all. Add backs help bridge the gap between tax-optimized financials and the actual performance of the business.

Nearly every small business has some legitimate add backs. These adjustments don’t mean the business is hiding anything; they’re simply a reflection of the way many owners manage their companies for tax efficiency rather than a sale. A proper recast of financials ensures the business is presented accurately and fairly. Here’s a simplified example of how SDE might be calculated:

Net Income: $100,000

+ Owner’s salary: $80,000
+ Personal vehicle expenses: $6,000
+ One-time professional fee: $10,000
+ Meals and entertainment: $4,000

= SDE: $200,000

SDE gives buyers a clear picture of what they’re actually acquiring and gives sellers a fair way to demonstrate the earning potential of their business.

Get in touch with the Business Seller Center to ensure your business is properly valued so you get the financial future you deserve. When it comes to selling your business, there are no do-overs.