Small business earnings definitions

When looking to purchase a business you will see all kinds of terms, many of which don’t make any sense. Here’s a list of common terms and a rough idea of what they mean:

Cash Flow – this is the worst definition used. It’s an attempt to convey how much money is available to a business owner after all the expenses of the business are deducted from the revenue. Unfortunately Cash Flow technically also would include any increase or decrease in working capital items like inventory, accounts receivables, etc.

Seller’s Discretionary Earnings (SDE) – This is calculated same as above but would include expense items added back that are not important to the business operations. Usually these add back items are owners “perks”…. country clubs, entertainment, etc.

EBITDA – This is ..(E) earnings (B) before (I) interest (T) taxes (D) depreciation (A) amortization. The I&T will be different for the buyer than the seller so they are added back and a buyer will need to account for there I&T costs based on their debt structure. D&A are added back because they are non-cash expense. Meaning you don’t write a check to pay for D&A like you do for payroll or utilities, therefore the deduction in the expenses is not real dollars but actually a tax deduction. Unfortunately (or fortunately) this does not adjust for a fair managers salary. Most business book the owners salary as “what’s left” after all expenses and this number can swing wildly from year-to-year.

EBITDA+OC – This is the best definition but the least used. It’s EBITDA as described above PLUS the owner’s compensation. This is the real comparison number that should be analyzed when investigating the profitability of a business.