that while a professional appraisal can be more accurate, it also leaves less room for negotiation

Median Cash Flow (Seller’s Discretionary Earnings)
BizBuySell’s Insight reports and listings refer to a business’ “cash flow” number, which is the net
income of a business after you add back in the owner’s salary and certain other expenses (full list
of inclusions here). This figure is also known the Seller’s Discretionary Earnings (SDE) of a
business.
This number is very important because it is the one figure that best represents what you can
actually expect to earn as an owner of a business. It is also important because it is the main
number that is used to calculate a business’ value.
Median cash flow of sold small businesses has held pretty stable over the last 3-4 years in the
$80,000 to $100,000.
$80,000 – Median Cash Flow for Sold Small Businesses in the 3rd Quarter of 2011
$100,000 – Median Cash Flow for Sold Small Businesses in the 3rd Quarter of 2015
Using Seller’s Discretionary Earnings to Determine Specific Business Pricing
The general sales numbers above are great for giving a general estimate. However, the reality is
people spend quite a bit lower or higher than the average when buying a business. To get a more
specific estimate of a business’ value, you must use Seller’s Discretionary Earnings (SDE). Once
you have SDE, you can then use the following formula to estimate a business’ value:
SDE x Industry Multiplier + Real estate + Accounts/receivables + Cash on hand + Any
other assets not included in the SDE multiplier – Business liabilities = Business’
Estimated Value
Calculate SDE
SDE gives you a good estimate of a business’ true revenue potential. You can calculate SDE by
taking the net income of a business, as reported on its tax return, and adding back certain
expenses. You should add back the owner’s salary, expenses that are aren’t essential to running
the business, and one-time expenses that are unlikely to recur.
According to Wayne Quilitz, President of business brokerage firm Murphy Valuation Services,
here are some examples of things that would be added back into the net income reported on the
business’ tax return to calculate SDE:
Owner’s salary and perks
Family members on payroll
Non-cash expenses such as depreciation and amortization
Leisure activities, such as business golf outings
Charitable donations
Any personal expenses, such as the purchase of a personal vehicle, that were noted as
expenses on the business tax return
Business travel that’s not essential to running the business.
One-time expenses that are unlikely to recur after the sale of the business, such as the
settlement of a lawsuit
Find out the right SDE multiplier
Generally, businesses sell for somewhere between 1 and 3 times SDE. This is called the SDE
multiple or multiplier, and it varies based on industry and geographic trends (market risk),
company size, the business’ tangible and intangible assets, independence from the owner (owner
risk), and many other variables. This is probably the most subjective part of valuing a business
because so many factors affect which multiple you should use.
You can find out an approximate SDE multiple by looking at BizBuySell data. They list multiples
by industry. BizBuySell uses the term “cash flow multiple,” but this is the same thing as SDE
multiple.
The average SDE multiple for all sold businesses in 2015 was 2.28.
SDE x 2.28 = Average business value
between the buyer and the seller.
How Industry Affects the Value of a Business
The sales price of a business can fluctuate a lot depending on industry. That is why it is important
to take industry specific details into account when buying a business and trying to figure out the
price tag.
We decided to take a look at restaurants because they account for nearly a quarter of all small
business sales (24%), easily making them the highest selling single category of small business
(buy a significant margin). Other high-selling small businesses include dry cleaners/laundromats,
bars/taverns, and convenience stores.
We included statistics from Dry cleaners/laundromats because they are the 3rd highest category of
business sold and are very different in nature than restaurants, making them an interesting
comparison.
Here is the information for sales in the Restaurant and Dry Cleaning/Laundry industries from the
report: There are several interesting differences that are worth discussing.
Sales Price
One of the first conclusions to draw from the data, is that on average, restaurants sell for around
$70,000 cheaper than dry cleaning/laundry service businesses. So, if you are undecided between
the two and are just looking for the cheaper option, then this difference in average price might
point you to purchasing a restaurant.
Revenue & Cash Flow
The differences between median restaurant revenue and median dry cleaning business revenue is
significant, with restaurants bringing in nearly twice the revenue of dry cleaning businesses.
However, restaurants also have high operating costs compared to laundromats. Laundromats’
primary costs are employees wages, equipment maintenance, and utilities (water, electricity, etc).
Restaurants tend to have more employees on average and more ongoing costs (purchase of food,
drink, etc.). As a result, both industries have roughly similar cash flow even though restaurants
bring in much more revenue. This would explain the major difference in the SDE multiples of the
two industries, 1.89(restaurants) vs. 2.69 (dry cleaning/laundry).
Also, dry cleaning/laundromats are generally assured of consistent and repeat customers. Unless a
customer buys a washer and dryer, there is very little reason for them to switch laundromats or
stop coming to a laundromat. If the atmosphere is safe and the equipment works, they are set.
Market Risk & Owner Risk
Industry and geographic trends influence the value of a business. This is often referred to as
“market risk.” A restaurant is a much more volatile industry when it comes to customer retention.
They are constantly competing with other restaurants on multiple fronts (price, food quality,
service). If a customer has one incident of bad service or poor food quality, they may never come
back.
In other words, the transferability and sustainability of a restaurant business is much less assured
than that of a dry cleaner/laundromat would be (there are exceptions of course).
Owner risk refers to how independent a business is from its current owner. Laundromats can
transfer ownership fairly easily with minimal impact on the customer base. In contrast, a
restaurant is often highly dependent on the owner. People may come to the restaurant because it’s
owned by a member of the local community or because a certain chef works there. If this changes,
they may stop going to the restaurant.
This is why looking at industry specific multipliers is so important when trying to figure out how
much you can expect to pay for a specific business.

Add other business assets to get business valuation

As a last step, you must add in assets that were not included in the SDE multiplier. For instance,
real estate, accounts receivables, and cash on hand must be added, and liabilities (e.g. debt,
interest) must be subtracted to get a business’ final valuation.
If this sounds too complicated, you can also skip the math and just hire a professional appraiser.
They will value the business for you and will charge around $2,000 to $3,000. Just keep in mind