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SDE vs EBITDA: What's the Difference?

SDE vs EBITDA: What's the Difference?
Lauren Ward
Lauren WardUpdated September 9, 2022
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SDE (seller’s discretionary earnings) and EBITDA (earnings before interest, taxes, depreciation, and amortization) are two methods to evaluate a company’s worth and earning potential.  While both are calculated by adding back certain expenses to net income, they have some distinct differences. Whether to choose EBITDA vs SDE to value your business comes down to your involvement in the day-to-day of your business, your business’s earnings, and your industry. Here’s a closer look at how EBITDA and SDE compare, how they are calculated, and which formula to use when. 

What is EBITDA?

Understanding what EBITDA is is simply a matter of understanding the acronym: EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA adds these four expenses back to net income to more accurately compare two or more companies that have different capital structures.Though EBITDA has its share of critics, there is a reasoning behind why this metric chooses not to include certain variables that are calculated as part of net income. Here’s a look.  
  • Interest: This refers to Interest on debt, including loans for small businesses. EBITDA excludes it because the amount of debt a company takes on depends on the financing structure of a company. Different companies have different capital structures and, as a result, widely different interest expenses. To better compare the relative performance of different companies, EBITDA adds interest paid on debt back to net income. Also, if the company is bought, the debt will likely not be included in the sale. 
  • Taxes: Taxes vary by region. As a result, companies with similar sales can pay vastly different amounts in taxes (such as those from payroll), which would affect their net income. This can make comparing two companies located in different regions difficult. To eliminate any possible obfuscation from taxes, it’s simply removed. 
  • Depreciation: Depreciation is the process of spreading out the cost of a tangible asset over the course of its useful life (the period of time the business expects to be able to use the asset). For many companies, depreciation is a very real cost that cannot be avoided. However, EBITDA adds this non-cash expense back to net income because it depends on the historical investments the company has made, not on its current operating performance. 
  • Amortization: Amortization is essentially the same as depreciation. The only difference is that amortization is used for intangible assets, such as patents, licenses, copyrights, and trademarks. Some companies will have more amortization costs than others. IBM, for example, files the most patents of any U.S. based company, and therefore must spend a large sum of money on amortization costs.
To quickly explain EBITDA: Any decision that revolves around accounting or financing is removed via the EBITDA formula so that what is left solely illustrates a company’s earning potential. 

How Is EBITDA Calculated?

There are two formulas to calculate EBITDA. Formula 1: Net Income + Interest + Taxes + Depreciation + Amortization = EBITDA Formula 2:Operating Income + Depreciation + Amortization = EBITDA Recommended: EBITDA vs NOI

What Is Seller's Discretionary Earnings (SDE)?

SDE, which stands for seller’s discretionary earnings, is a formula often used in mergers and acquisitions to assess a company’s worth. SDE essentially calculates the total financial benefit that a single full-time owner-operator would derive from a business on an annual basis. Like EBITDA, SDE removes the effects of interest on all types of business loans, taxes, and depreciation/amortization expenses. However, it goes a step further by also adding back to net income any kind of compensation the owner received. For some businesses, this can be a lot of money, while for others it can be very little.  In some cases, two companies will have the same net income, yet have vastly different SDEs because of owner compensation. For a potential buyer, this would make the company with the higher SDE a much more attractive option. 

How Is SDE Calculated?

SDE represents the earnings of a business prior to income taxes, depreciation, amortization, interest, and the owner's entire compensation (including benefits and any non-business or personal expenses paid by the business).To calculate SDE, the following expenses are added back to net income:
  • Owner Compensation:
    • Salary and any benefits 
    • Discretionary expenses, such as:
      • Home office supplies
      • Travel expenses
      • Professional dues
      • Research
    • Non-recurring expenses, such as:
      • New computer/ technology
      • Legal fees/ expenses
    • Non-business/ personal expenses
      • Vacations
      • Personal phone bill
      • Personal gas
      • Entertainment
  • EBITDA
    • Interest on debts
    • Business taxes
    • Depreciation
    • Amortization
The formula for SDE is:EBITDA + Any type of owner compensation = SDE

SDE vs EBITDA Compared

Here’s a closer look at the similarities and differences between SDE and EBITDA.

Similarities

  • Both SDE and EBITDA remove the effect of interest, taxes, depreciation and amortization from a company’s net income. 
  • Both attempt to standardize earnings by excluding certain items that are variable from one business to another. 
  • Either SDE or EBITDA may be used to value companies making between $1 and $1.5 million. 

Differences

  • SDE goes a step further than EBITDA by adding back any kind of owner compensation or perks. 
  • SDE is used when valuing smaller companies, while EBITDA is more commonly used when valuing large companies.
  • EBITDA allows investors to compare your business against others in the same industry, whereas SDE tells an individual looking to acquire your business how much they would make if they worked full-time in the business.
Here’s a side-by-side comparison of SDE vs EBITDA:

Pros and Cons of Using SDE

There are both advantages and disadvantages to using SDE to gauge the value and earning potential of a small business. Here a look at how they stack up.

SDE vs EBITDA Example

Company XYZ:

SDE Example

SDE for Company XYZ:Net income + Interest + Taxes + Depreciation + Amortization + Owner Compensation = SDE$275,000 + $50,000 + $250,000 + $75,000 + $25,000 + $200,000 = $875,000SDE  = $875,000

EBITDA Example

EBITDA for Company XYZ:Net income + Interest + Taxes + Depreciation + Amortization = EBITDA$275,000 + $50,000 + $250,000 + $75,000 + $25,000 = $675,000EBITDA = $675,000 The company’s SDE is significantly more than its EBITDA because the owner is taking a compensation of $200k. For a potential merger or acquisition, this is a significant increase in profits. Any potential buyer would likely be interested in both numbers because the compensation the current owner is taking could be used for bootstrapping.  

When to Use EBITDA vs SDE

Here’s a general rule of thumb for when use EBITDA vs SDE:
  • EBITDA should be used by companies making more than $1.5 million in revenue each year.
  • SDE should be used by companies making $1 million or less. 
  • Analysts looking at companies making between $1 million or $1.5 million can use either method. 

The Takeaway

Both EBITDA and SDE are earnings metrics used to help determine the value of an organization. EBITDA removes the effects of interest, taxes, depreciation, and amortization by adding them back to net income. SDE does this, too, but also adds back any form of owner compensation.SDE is more commonly used than EBITDA to value small businesses that are owner-operated. If you own a small business, knowing its SDE can be useful, even if you’re not intending to sell. This valuation can give you insight into the true earnings of your business. It can also help you avoid future valuation gaps, as well as identify weaknesses in your company that need addressing. Knowing your business’s SDE and/or EBITDA can also be useful if you are looking to get a small business loan at some point in the future. Lenders will often look at different earnings metrics to determine whether a company is producing enough  cash flow to manage the payments on a loan. 

3 Small Business Loan Tips

  1. Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can compare small business loans by filling out one application on Lantern by SoFi.
  2. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
  3. SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.

Photo credit: iStock/mapodile
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Frequently Asked Questions

Is SDE the same thing as EBITDA?
How do you calculate SDE?
What is considered a good SDE multiple?

About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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