What is seller's discretionary earnings (SDE)? How to calculate it

Why your tax return understates your business

A good accountant keeps your taxable profit low. Depending on how your business is taxed, your pay, the truck, the phone, the family health plan and the trip that was partly a conference can reduce the profit on the return, legally. Ask your accountant how your own return treats each one.

A buyer is asking a different question: if I owned this, how much money would it produce for me? SDE answers it.

Small-business accounts are prepared for tax reporting, not to show a buyer the cash flow available to an owner. Recasting presents the same records in the way buyers and lenders assess them.

The SDE formula and worksheet: how to calculate it

SDE = pre-tax profit + owner's pay + interest + depreciation and amortization + personal expenses + one-off costs, minus one-off income

An add-back is an expense in your books that a new owner would not have to pay, so you put it back into profit. Amortization is depreciation for intangible things, such as a purchased customer list.

Start with	Pre-tax profit from the tax return or profit-and-loss statement
Add back	The owner's salary, payroll taxes and benefits
Add back	Interest, depreciation and amortization
Add back	Personal expenses paid by the business
Add back	One-off costs that will not recur
Take off	One-off income that will not recur
Equals	Seller's discretionary earnings

Where to find each number on your tax return

Use the return your business files: Schedule C for a sole proprietor (and most single-member LLCs), Form 1120-S for an S corporation, Form 1065 for a partnership. A C corporation files Form 1120 and pays income tax itself, so start from its profit before that tax. An LLC with two or more owners usually files Form 1065. Line numbers are from the IRS instructions for 2025 returns and change yearly, so check your form.

1. Start with profit. Schedule C: line 31, net profit. Form 1120-S: line 22, ordinary business income. Form 1065: line 23, ordinary business income.
2. Add back the owner's pay. Form 1120-S: line 7, compensation of officers, plus the payroll taxes and benefits paid on it. Form 1065: line 10, guaranteed payments to partners, if you are paid that way (a profit share is already in line 23). Schedule C: no pay line, because what a sole proprietor takes out is not a deduction.
3. Add back interest. Schedule C: lines 16a and 16b. Form 1120-S: line 13. Form 1065: line 15.
4. Add back depreciation and amortization. Schedule C: line 13 (amortization sits in other expenses, Part V). Form 1120-S: line 14. Form 1065: line 16a, which includes any depreciation inside cost of goods sold. On Schedule C and Form 1120-S, depreciation booked inside cost of goods sold (the direct cost of materials and labor) is not on these lines: ask your accountant for the total.
5. Add back personal and one-off costs. These have no line of their own. Schedule C: car and truck (line 9), legal and professional services (line 17), travel and meals (line 24). Form 1120-S and Form 1065: usually inside other deductions (line 20 and line 21 respectively). Go through the ledger and card statements to find them.
6. Take off one-off income, such as a recovered bad debt. Look in other income: Schedule C line 6, Form 1120-S line 5, Form 1065 line 7.

A worked example: an S corporation

A plumbing company, taxed as an S corporation, reports $212,000 of profit on its return. The owner pays herself a $150,000 salary, and the business pays about $12,000 of payroll taxes on it. The figures in this example and the next are made up.

Profit on the tax return (Form 1120-S, line 22)	$212,000
Owner's salary and payroll taxes	+ $162,000
Depreciation and interest	+ $41,000
Family vehicle, phones and travel	+ $31,000
One-off legal bill for a lease dispute	+ $18,000
SDE	$464,000

In this example, the business she thought made a couple of hundred thousand dollars produces more than twice that for its owner. The difference changes the price. If you own an HVAC, plumbing or electrical company, selling an HVAC, plumbing or electrical business shows how buyers in those trades read the same numbers.

A worked example: a sole proprietor

A sole proprietor has no salary on the return, so there is no pay to add back. Adding a salary that was never deducted overstates SDE, and a buyer's accountant is likely to catch it. A landscaping business with one owner reports $180,000 of net profit.

Net profit (Schedule C, line 31)	$180,000
Owner's pay	+ $0
Interest (lines 16a and 16b)	+ $9,000
Depreciation (line 13)	+ $24,000
Personal share of the truck, phone and family travel	+ $14,000
One-off equipment repair after a flood	+ $7,000
SDE	$234,000

SDE or EBITDA?

Buyers of smaller businesses usually think in SDE, because many expect to work in the business and take the owner's pay themselves. The International Business Brokers Association (IBBA) and M&A Source publish a quarterly survey of business brokers and advisors, the Market Pulse. Its Q2 2026 highlights show deals up to $2 million as multiples of SDE, and deals from $2 million to $50 million as multiples of EBITDA (earnings before interest, taxes, depreciation and amortization).

Buyers of larger businesses more often use EBITDA. It assumes a manager is paid a market wage to run the business, so only the owner's pay above that wage is added back. If a manager would cost $110,000 and you pay yourself $150,000, the add-back is $40,000, not $150,000.

Quote the wrong one and a buyer may question the price. SDE vs EBITDA puts one business through both and shows which your buyer is likely to use.

What is a good SDE multiple?

A multiple is the price divided by SDE, and it generally rises with the size of the deal. In Q2 2026, brokers and advisors reported SDE multiples of 2.0 for deals under $500,000, 2.8 for $500,000 to $1 million, and 3.1 for $1 million to $2 million. That is one quarter's survey, completed by 255 business brokers and advisors. The highlights do not say whether the multiples are averages or medians, and do not split them by industry.

For example, at the 2.8 reported for the $500,000 to $1 million band, a business with $300,000 of SDE would be priced at $840,000. The figures are made up. Where a business lands tends to depend on how verifiable and transferable its earnings are. What is my small business worth? covers what moves a business up or down the range. For a number on your own business, ask a broker or a certified appraiser.

Does SDE include the owner's pay, and what else is it called?

Yes. SDE is measured before the owner's pay, so it counts all of it, with profit and perks. In plain terms it is the owner's cash flow from the business, not net profit and not cash in the bank.

The IBBA's glossary calls the measure discretionary earnings. It lists seller's discretionary earnings, seller's discretionary cash flow (SDCF) and adjusted net as other terms used, and owner benefit as another name. When a listing or an offer says "cash flow", ask exactly what has been added back.

Four mistakes that make buyers distrust your SDE

1. Add-backs with no paperwork. Buyers are far more willing to accept an add-back they can trace to an invoice or a statement line. See which add-backs buyers accept.
2. Adding back costs the business needs. Your spouse's salary is an add-back only if your spouse does not really work there. If your spouse works there and is paid above the going rate, only the excess is an add-back.
3. Counting two owners as one. SDE assumes one full-time owner. If two of you work in the business, a buyer will usually subtract a market wage for the second. The IBBA glossary does the same: other owners' pay is adjusted to market value.
4. One good year. Buyers usually look at the last three years and weight the trend. A single strong year does not set the price.

What to do with the number

Work out SDE for each of the last three years. If it is rising, that is your best sales argument. If it is falling or uneven, you need the explanation ready before a buyer asks. SBA lenders ask for the same span: an application for an SBA 7(a) loan (a bank loan backed by the US Small Business Administration) to buy an existing business includes the seller's financial statements for the last three complete fiscal years, or the years in business if fewer (SBA SOP 50 10 8.1, Appendix 20).

Keep each year's calculation, with the paper behind every add-back, in the folder a buyer will ask for: the documents buyers and lenders ask for. A buyer's accountant is likely to redo it, sometimes as a formal quality of earnings report.

How to sell a small business shows where this number fits in the whole sequence.

Keep reading

• SDE vs EBITDA: which one will a buyer use to price your business?
• Add-backs when you sell a business: what buyers accept
• What is my business worth? How to value a business for sale

This guide is general information, not tax, legal or valuation advice. Every business is different: talk to your accountant, lawyer and broker about yours.