Seller’s discreationary cash flow equals the pre-tax earnings of the business before non-cash expenses, one owner’s compensation, interest expense or income, as well as one-time and non-business related income and expense items. If additional owners work in the business, their compensation needs to be adjusted to market rates.
What It Means
Seller’s discretionary cash flow or SDCF is also known as SDE or seller’s discretionary earnings. It represents a common cash flow based measure of business earnings for owner-operator managed businesses. According to the International Business Brokers Association, you can calculate the SDCF as follows:
- Start with the business pretax earnings.
- Add non-operating expenses and subtract non-operating income.
- Next add unusual or one-time expenses and subtract non-recurring income.
- Add depreciation and amortization expenses.
- Then add interest expense and subtract interest income.
- Add a single owner’s total compensation.
- Adjust compensation of all other business owners to market value.
Using SDCF in business valuation
Multiple of discretionary earnings method
SDCF serves as a key input for the Multiple of Discretionary Earnings business valuation method.
Valuing a business by market comparisons
In addition, SDCF provides the earnings basis for common valuation multiples. To come up with such a multiple, you would follow this procedure:
First, you would start with the business income statements of comparable companies. Next, you adjust their net income with so-called addbacks shown in the list above. You then calculate the ratios of businesses’ sold prices to their discretionary earnings. This gives you a set of valuation multiples to use in your own company valuation. Finally, you apply the multiples to estimate the market value of your business in comparison to similar companies that sold recently. As a result, you get a defensible business value estimate based on Market Comps.
Note that seller’s discretionary cash flow and seller’s discretionary earnings mean the same thing. You will run across both of these terms in small business acquisition situations as professional business brokers use them.