Does the Profit of the Business Work for You as a Business Buyer?

**This article is for those business buyers who are buying a business and will be operating the business. This is not for “passive” investors.**

Most business buyers are purchasing a business to gain more control of their day-to-day activities and for future security. A critical element when looking at a particular business is to determine if the business will meet your financial requirements.

First some definitions.

When looking for a business to buy you may see several different terms that presumably identify the “profits” of the business.

SDE = Seller’s Discretionary Earnings SDE is the profit of the business BEFORE expenses for the current owner salary, income taxes, depreciation, interest and any other owner benefits (country club, travel, etc)

Here are some other terms you’ll see that attempt to convey the same information: Cash flow, ebitda+owners comp, net profit to owner, seller’s discretionary cash flow (SDCF), there are others. Make sure you understand how the amount was determined before making any decisions. Also conduct your own, independent, due diligence to make sure you have confidence that the representations made are accurate.

But let’s forget the definitions for a moment and let’s talk about what’s important to a buyer. What you as a buyer want to know is this:

“After the expenses of the business are paid how much income, in cash, is available to pay me a salary plus pay my debt payment requirements if I buy this business?”

In order to answer that question you need to answer these questions:

• How much has the business made in the past? Can I make the business do more? Less? Will I have expenses for new equipment to make after I purchase the business? If yes, how will I pay for those purchases? After due diligence do I have confidence that the business earnings are as they were represented?

 

• How much debt service will I have to pay? This is easy, purchase price minus the down payment = debt. If the debt is 9% interest for 10 years you can use an amortization table to give you the monthly payments. (You can go to Amortization Calculator for a calculator).

 

• Finally, but most importantly, you need to know how much income you need from the business to serve your personal requirements for income. I suggest that it not be what you’d LIKE to make but what you NEED to make. Under-estimating this number could lead to cash flow problems, over-estimating this number could cause you to pass on a business that may have been a good fit for you.

There you are…. take the SDE – your salary – debt service. If you have a negative number the deal doesn’t work. If it’s a positive number the deal may work and you can move ahead to the other steps in the business buying process.

The process of buying a business can be frustrating. Spend some time making sure you know what you’re looking for and what to investigate once you find it. Due diligence is important, be prepared to conduct thorough and efficient due diligence.

Yes, profit available exceeds requirements

Copyright 2007 Daniel Elliott