The appraisal industry is full of acronyms that only those well-versed in the industry can easily identify. Two of the more important abbreviations that factor significantly in the overall valuation of your small business are discussed below:
EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization
EBITDA is a measure of a company's profitability or cash flow; however, it may not fully reflect cash earnings. EBITDA considers a wide range of factors in business finances. It is considered a universally accepted appraisal measurement and is also used in accounting circles.
From an application perspective, it is used by banks and financial services companies to estimate debt servicing levels. It is also used to compare similar businesses within an industry or market and to preliminarily estimate a company’s current value using multiples of EBITDA derived from historical databases.
In a buy/sell scenario, adjusted EBITDA will also factor in discretionary and non-recurring expenses, which leads you to the following term:
SDE: Seller’s Discretionary Earnings
Seller's Discretionary Earnings (SDE) is a calculation that considers a business's net profit and adds back discretionary adjustments to show the full financial benefit to an owner or prospective buyer.
SDE is therefore a relevant income measurement calculated when a business is changing hands. Financial data associated with this calculation includes EBITDA, as well as non-recurring and discretionary expenses that won’t impact a company's future value from a new owner’s perspective.
If you're on the acquisition side, SDE provides a necessary benchmark to develop a reasonable estimate of your expected annual return on investment, as well as an understanding of realistic expectations for the business's continued growth. From the seller’s viewpoint, SDE supports an optimal level of value during sale negotiations. SDE allows both buyers and sellers to make informed decisions while preparing to invest in or exit a small business.
In summary, whether you’re conducting a formal independent valuation for a client or involved with the sale or purchase of a small business, EBITDA and SDE are two important data points that will be used measure both the current and future value of a small business.