Murphy Moment: Business Valuations Explained (almost weekly email)
May 24, 2024 8:47 pm
From the Desk of Josh Grode Wolters, MBA...
I promise I'll have some juicy new listings next week. However, this week you'll have to be content with a little educational moment. Warning: this email may be especially helpful for insomniacs looking to get some sleep😴. Most folks find this type of thing boring, but the art and science of business valuation absolutely fascinates me! #nerd
As with any industry, Business Brokers and M&A professionals use a variety of jargon and acronyms. I wanted to take a moment to explain the key financial metrics, Seller’s Discretionary Earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), as they are crucial for evaluating the financial health and valuation of a business, especially in the context of acquisitions and investments.
Seller’s Discretionary Earnings (SDE) is a measure often used for small businesses (think revenues <$5MM). It represents the total financial benefit the owner derives from the business. SDE is calculated by taking the business’s net profit and adding back owner’s salary and benefits, non-cash expenses like depreciation, one-time expenses, and any other discretionary expenses. This metric is particularly useful because it provides a clear picture of the actual earning potential and cash flow available to a new owner, helping potential buyers understand the true value of the business.
On the other hand, EBITDA is a broader measure of a company’s overall financial performance and is commonly used for larger businesses. EBITDA focuses on the core operating profitability by excluding non-operating expenses such as interest, taxes, depreciation, and amortization. This metric allows investors and analysts to compare companies on an equal footing by removing the effects of financing and accounting decisions. While EBITDA doesn’t account for changes in working capital or capital expenditures, it is a valuable indicator of the business’s ability to generate consistent operational earnings.
Understanding both SDE and EBITDA is essential when assessing a business for purchase or investment. While SDE gives insight into the earnings available to the owner, EBITDA provides a standardized measure of operational performance. Depending on the size and nature of the business, one metric may be more relevant than the other, but together they offer a comprehensive view of a company's financial health and profitability.
As always, I'm looking forward to hearing from you soon!
Happy Friday,
Josh
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JOSH GRODE WOLTERS, MBA
Business Intermediary
