Seller's Discretionary Earnings Calculator
Answers the Question
How much is a small business worth?
Calculator for Seller's Discretionary Earnings
What Is the Seller's Discretionary Earnings?
This is a measure of profitability, from the perspective of an owner who also works for the firm. Unlike traditional measures like net profitability which examine how much a buyer might earn from owning the business, it also includes the earnings a buyer would accrue from working at the business
Why Is it Important?
- Many measures of business profitability only show half of the picture. They show how much a firm makes after everyone is paid, without noting how much the owner is paid for his own labors. For many small businesses, this can lead to radically lower valuations for small businesses.
Formula(s) to Calculate Seller's Discretionary Earnings
- SELLER'S DISCRETIONARY EARNINGS = PROFIT + (NONRECURRING EXPENSES - NONRECURRING INCOME) + (NONOPERATING EXPENSES - NONOPERATING INCOME) + DEPRECIATION + AMORTIZATION + INTEREST EXPENSES + OWNER'S COMPENSATION
- Assuming that a company's value is always a function of its profitability. Some firms have valuable assets that are not being used effectively and can either be sold or utilized differently.
- Assuming that the seller's discretionary earnings will remain static after a purchase. Given that a new buyer will often possess his own levels of skills and abilities, a firm's ability to produce earnings may change radically.
- Assuming that more attractive businesses necessarily have higher discretionary earnings. The higher values may come at a cost - namely, that a greater quantity of labor and effort is required to run the business.
- Assuming that buyers want to work. Many people believe that the best income is passive, and then buying a business that requires significant labor is simply buying a job rather than buying a business.
- Assuming that what one party views as a one-time expense or income will be seen in the same way by the other party. Each has an incentive to be more or less conservative for each evaluation.
- Ignoring growth. High-growth firms will necessarily be undervalued by this method as increases in profitability are not represented by these figures.