Profit Isn’t Just One Number: What Buyers Actually Look At
Back in university, we started a software company armed with nothing but a half-baked idea and a 40-page business plan that we thought was brilliant. As the token business student in the group, I proudly filled that plan with revenue projections and an estimate of how much profit we were going to make. To make us sound smarter, I quickly threw in the term "EBITDA” for profit calculation because I’d heard people say it and sounded way smarter than just saying “profit”.
We walked confidently into a meeting with our mentor who promptly tore the whole thing apart. Near the end, he pointed at our financial section and said, “What do you actually mean by EBITDA?”
I was able to smugly say what the acronym stands for: Earnings before Income Tax, Depreciation, and Amortization. He went on to rattle off all the different kinds of profit like net income, gross profit, operating income, SDE, EBITDA, and there wasn’t a chance in hell that I could explain any of those. Thanks, business school.
If you're reading this and thinking, isn’t profit just how much money you have left over after costs? you're not alone. Most business owners don't realize that "profit" is more like a category and when you're getting ready to sell, knowing the difference between these definitions can make a massive impact on your valuation.
Let’s break it down.
So, What Is “Profit” Really?
When someone asks, “Is your business profitable?” you probably think: How much ends up in my pocket at the end of the day?
Seems simple. But in practice, there are multiple definitions of profit and each of them serves a different purpose depending on who's asking and why.
Net Income: The One Your Accountant Cares About
If profit was a house, Net Income is the foundation. This is the number at the bottom of your income statement. It’s calculated as:
Revenue – Cost of Goods Sold – Expenses = Net Income
It’s the number your accountant uses to calculate taxes. And if your accountant is doing their job well, they’re trying to make that number look as small as possible by maximizing deductible business expenses.
But what’s great for tax season isn’t always good for business selling season.
That minimized profit number can make your business look weaker than it actually is, especially if you’re running legitimate personal expenses through the company or claiming paper losses like depreciation.
Which brings us to the next version of profit...
Seller’s Discretionary Earnings (SDE): The Small Business Standard
If you’re in the market for buying or selling a business, you will hear the term Seller's Discretionary Earnings or SDE thrown around a lot. You can think of SDE as equivalent to the maximum owner financial benefit of running a business. This is a lot more common in smaller Main Street deals where the owner typically plays an important role in the operation of the business.
To calculate the SDE of a business, we start with the Net Income that was reported on the business’ tax filings and we add back certain line items from the Profit & Loss statement to get a more accurate picture of profit. The basic types of add-backs that are included in an SDE calculation are the following:
Owner’s Salary – If you’re paying yourself through payroll, we add that back in.
Depreciation & Amortization – Non-cash expenses that reduce tax liability.
Interest – Financing structures vary, so buyers ignore yours.
Personal Expenses – Like meals, your car, or your cell phone.
One-Time Costs – Unusual legal fees, rebrands, or pandemic pivots.
Let’s say your plumbing business shows a Net Income of $100,000. But your financials also include:
Owner Salary: $150,000
Amortization: $30,000
Meals & Entertainment (Personal): $2,500
Your SDE would be:
$100,000 + $150,000 + $30,000 + $2,500 = $282,500
Suddenly, your business looks a whole lot more valuable to a buyer.
Adjusted EBITDA: Taking the Owner Out of the Picture
If SDE is about owner benefit, Adjusted EBITDA is about investor return. It’s commonly used when a buyer wants to understand how much the business can make without the owner working in the business.
To get Adjusted EBITDA, we take your SDE and subtract the cost to replace you with a manager.
Adjusted EBITDA = SDE – Market Salary for Replacement Role
Why does this matter?
Even for small businesses, buyers want to understand what the business would earn if they didn’t have to work in it or if they had to hire someone else to run it. Even if you think, “There’s no way anyone else could do what I do,” that’s fine. But buyers still want to model the hypothetical and gauge whether the deal works as a true investment.
Why This All Matters When You Sell
When you’re selling a business, you’re not just selling a property, you’re telling a story.
If we only looked at your tax returns, most businesses would seem far less profitable than they really are. And buyers would pay less. A lot less.
Understanding these different profit metrics and organizing your financials in a way that reflects the true earning potential can significantly increase the value of your business in the eyes of a buyer.
So the next time your broker asks how much you spent going out to eat, just remember: they’re not judging your lunch habits. They’re trying to get you the best price for your business.
