What it means
In a small business, the owner often pays themselves a modest salary, runs personal costs through the company and makes choices that suit them, not a future buyer. As a result, the reported profit can say little about what the business really earns.
SDE strips out these owner-specific items to show the full cash benefit available to one person who works in the business full time. The usual starting point is pre-tax profit from the accounts.
To that figure you add the owner's salary and benefits, interest on loans, depreciation and amortisation (the gradual write-off of equipment and intangible assets), and any one-off or personal expenses. The result is the pool of earnings an incoming owner could use to pay themselves, repay a loan and reinvest.
SDE is different from EBITDA (earnings before interest, tax, depreciation and amortisation). EBITDA assumes a manager is paid a market salary, so it is used for larger companies run by hired managers.
SDE leaves the owner's pay in the total, which suits businesses where the owner is the manager, such as a dental practice, a cafe or a plumbing firm. The most important judgement is deciding which expenses are genuinely personal or one-off.
A buyer will examine every add-back and may reject any that look like normal running costs, such as a vehicle the business truly needs. Add-backs should be documented with invoices and clear explanations, because an unsupported add-back is the first thing a buyer's adviser will challenge.
Once SDE is agreed, a valuation multiple is applied to it. Small businesses commonly sell for a multiple somewhere in the low single digits, depending on the industry, growth, customer concentration and how dependent the business is on the owner.
The multiple is a negotiated figure and not a fixed rule. The main limitation is that SDE ignores the cost of replacing the owner.
A buyer who plans to hire a manager must subtract that salary, so the same business can look attractive to an owner-operator and poor to an investor. Always ask who the number is meant for.
In practice
Real-world examples
Example 1
A baker wants to sell her two-shop business and asks a broker for a valuation. The broker adds back her salary, her family's phone plan and a one-off refit cost. The resulting SDE becomes the basis for the asking price, and the broker explains each adjustment in a short schedule so that buyers can follow the logic.
Example 2
A buyer is looking at a small accounting practice and sees an owner who pays himself $60,000. The seller claims an SDE far higher than the reported profit. The buyer asks for payroll records and tax returns to check each add-back. Only the items that can be proved are kept, and the price is adjusted to match.
Example 3
A bank is asked to lend money for the purchase of a pest control company. The loan officer compares the SDE with the proposed loan repayments to see if the new owner could pay themselves a living wage and still cover the debt. A loan that the SDE cannot comfortably support is declined or reduced.
Think of it
SDE is like looking at the fuel efficiency of a second-hand car after removing all the heavy personal junk in the boot. It shows you how the vehicle performs on its own, rather than how weighed down it was by the previous driver.
Formula
Calculation
SDE = pre-tax profit + owner's salary and benefits + interest + depreciation and amortisation + one-off and personal expenses
Suppose a landscaping firm reports pre-tax profit of $120,000. The owner takes a salary of $90,000 and runs $15,000 of personal vehicle and phone costs through the business. The firm paid $10,000 of loan interest, recorded $20,000 of depreciation and spent $5,000 on a one-off legal dispute. SDE = 120,000 + 90,000 + 15,000 + 10,000 + 20,000 + 5,000 = $260,000, and at a multiple of 2.5 the indicated value is 260,000 x 2.5 = $650,000.Case study
Seen in the real world
Lakeside Marine Services is an illustrative, fictional boat repair business that reported a profit of only $40,000 last year. The owner, who works full time in the yard, wanted to retire and sell.
An adviser rebuilt the earnings. She added back the owner's $85,000 salary, $12,000 of personal costs, $8,000 of interest and $15,000 of depreciation, giving SDE of $160,000. A buyer's accountant challenged the personal costs and agreed to only $6,000 of them.
The final agreed SDE was $154,000 and the sale price was set at a multiple of 2.2. The illustrative lesson is that every add-back is a negotiation, and that clean, documented records protect the seller's price. Had the owner kept personal and business spending apart for years, the debate would have been shorter and the final figure higher.
Watch out
Common mistakes
- Adding back genuine operating costs, such as a delivery van the business needs, and presenting them as personal expenses.
- Using SDE for a company run by a hired manager, where EBITDA is the better measure.
- Forgetting that the buyer must live on the SDE, so a high price relative to SDE leaves little for the buyer's own pay.
Questions
People also ask
Is SDE the same as net profit?
No, net profit is the accounting result after all costs, while SDE adds back owner pay and other items to show the total benefit to a working owner.
What multiple is normally applied?
Small businesses usually sell at a modest multiple of SDE that varies by sector, size and risk, so ask a broker for comparable sales rather than rely on a rule of thumb.
Who calculates SDE?
Business brokers and valuers usually prepare it, but both buyer and seller should review the add-backs with an accountant.