As a business broker, you are often asked to provide a valuation for a business. There are many different methods and metrics that can be used to value a business, and it is important to understand the strengths and limitations of each approach. Two common metrics that are used in business valuations are EBITA (Earnings Before Interest, Taxes, and Amortization) and SDE (Seller’s Discretionary Earnings). While these two metrics may seem similar at first glance, there are some important differences that you should be aware of.
EBITA is a measure of a company’s profitability that excludes certain non-cash expenses, such as depreciation and amortization. It is calculated by taking a company’s earnings before interest, taxes, and amortization (EBITA) and adding back any non-cash expenses. This measure is often used to compare the profitability of different companies, as it helps to eliminate the impact of non-cash expenses on the bottom line.
One of the main advantages of using EBITA in a business valuation is that it provides a more accurate representation of a company’s operating performance. By excluding non-cash expenses, EBITA helps to focus on the underlying performance of the business, rather than the impact of one-time or non-recurring events.
However, there are also some limitations to using EBITA in a business valuation. One of the main limitations is that it does not take into account the impact of financing on a company’s profitability. For example, a company with high levels of debt may have lower EBITA due to the interest expenses associated with its borrowing, even if it is otherwise performing well. As a result, EBITA may not always provide an accurate representation of a company’s true profitability.
SDE is another measure of a company’s profitability that is commonly used in business valuations. It is calculated by taking a company’s net income and adding back certain non-cash expenses, such as depreciation and amortization, as well as certain owner’s salary and benefits. This measure is intended to represent the income that is available to the owner of the business after all expenses have been paid.
One of the main advantages of using SDE in a business valuation is that it takes into account the impact of the owner’s salary and benefits on the company’s profitability. This can be particularly important in small businesses, where the owner may be heavily involved in the day-to-day operations of the business. By including the owner’s salary and benefits in the calculation, SDE provides a more accurate representation of the income that is available to the owner after all expenses have been paid.
However, there are also some limitations to using SDE in a business valuation. One of the main limitations is that it may not be consistent across different businesses. For example, the owner of one business may choose to pay themselves a higher salary and benefits than the owner of another business, even if the two businesses are otherwise similar in terms of size and profitability. As a result, SDE may not always provide an accurate comparison of the profitability of different businesses.
In summary, EBITA and SDE are both useful measures of a company’s profitability that can be used in business valuations. However, it is important to understand the differences between these two metrics, as well as their strengths and limitations. EBITA is a measure of a company’s profitability that excludes certain non-cash expenses, while SDE is a measure of the income available to the owner of the business after all expenses have been paid. Both measures can be useful in different situations, but it is important to consider the specific needs of the business being valued when deciding which metric to use.
