In the process of buying and selling Amazon FBA businesses, the term SDE (Seller’s Discretionary Earnings) plays an important role. For sellers, it is very important to know the value of the SDE, to maximize their earnings from the sale, and understand the fairest price to ask for their business.
For buyers, the SDE value is a guide for the expenses and profit of the business, so they can offer a fair price and negotiate the terms and conditions. However, not many sellers understand or know how to properly calculate this number.
We’ve created this guide to simplify the SDE meaning and calculation. Our guide explains in detail what SDE is and how it is properly calculated.
SDE (Seller Discretionary Earnings) is the total financial benefit that a business would generate in a timeframe of one year.
What is SDE meaning in a business valuation?
SDE can also be known as Adjusted Cash Flow, Total Owner’s Benefit, Seller’s Discretionary Cash Flow, Recast Earnings, or Discretionary earnings. It’s up to the aggregator to choose which term they use in their legal paperwork; the most common acronym used is SDE.
The simple SDE formula would be:
SDE = Net Profit + Add-backs
Here is how to calculate each section of the formula:
1. Net Profit
The net profit of the business is calculated based on EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization). EBITDA shows how much profit the company is making and gives an estimation of how much the buyer would earn after the purchase.
What is the difference between EBITDA VS SDE?
The main difference between SDE vs EBITDA are:
– EBITDA doesn’t contain the owner/manager’s salary while SDE does contain the owner/manager’s salary normal;
– EBITDA is used to calculate the profit of larger companies with more elaborate financial reports, while SDE is used for small to medium businesses with a profit of less than 5 million USD Add-backs or Seller Discretionary Expenses.
Add-backs are expenses that are discretionary for the owner – the buyer won’t inherit them after the purchase.
There are four types of Add-backs:
1. The annual salary of the owner
The owner’s payment is the number one add-back to the business. The owner chooses their payment, making it as large or small as they like – so that number can always be added back to the net profit. Payments to coworkers, employees and managers can’t be considered as add-backs because those people will continue to work and contribute to the business after the sale.
2. Discretionary expenses
Seller’s discretionary expenses are all expenses that benefit the owner, rather than the business or its employees, but they are paid from the business and appear on the tax return form and PL statement. These discretionary expenses will be returned (added back to the business value after the sale). Where discretionary meaning that the expense is available to use at the discretion of the user. It’s a common business practice that happens in almost every business – and it’s one of the most common pain points for sellers and aggregators.
Buyers can have difficulty deciding on what classifies as a discretionary expense because sellers often mix personal and professional expenses. To avoid this situation, it’s best to keep personal and professional expenses separate for at least three years.
3. Non-recurring expenses
Non-recurring expenses are one-off expenses that aren’t likely to happen again, like repair, upgrade, or relocation costs. Sellers should be careful about these expenses, retaining all documentation to prove to the buyer that these expenses won’t happen again soon.
4. Other expenses
This category covers all expenses that can’t be classified under any other add-back. Such expenses include the sale of equipment, inventory adjustments, etc.
Our simple table will help you determine whether an expense is an add-back or not:
|Most Common||Discretionary expenses||Non-Recurring||Other|
|Owner Payment||Personal contributions||Lawsuit settlement and other legal expenses||Car expenses|
|Owner Payment Taxes and Benefits||Business travel expenses ||Software and hardware upgrade||Inventory Adjustments|
|Any owner personal expenses||Family mobile phone plan||Relocation, expansion, renovation expenses||Rent charges for home office|
|Depreciation and Amortization||Sponsorships||Application fees||Non operating income|
However, not everything can be calculated as an add-back.
We’ve created a list of all the items you should take into consideration.
What wouldn’t qualify as an add-back:
– Employee medical insurance and payments
– Food, transport, and entertainment expenses for employees
– Marketing and promotion expenses
– Club memberships for employees
– Personal purchases on a business credit card
– Employees gift cards, vouchers, and discounts