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seller’s discretionary earnings

5 Accounting Tips to Increase the Value of your Business

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1.  Stop minimizing taxes; instead maximize reported profitability

Many small businesses utilize the cash-basis of accounting rather than the accrual basis.  Doing so enables businesses to accelerate expenses into the current tax year and defer revenues to the following tax year.  This is a very aggressive method of minimizing taxes, and it follows that this method minimizes earnings and unfortunately minimizes business valuations.

2.  Eliminate excessive personal expenses and skimming cash

Similarly, if you run personal expenses through your business to minimize taxes, that practice is counterproductive to the value of your business.  Although some of those expenses might be able to be “sold” as add-backs to arrive at seller’s discretionary earnings (SDE), buyers often fight those adjustments and lenders will not consider them at all in determining the value of the business

3.   Stop expensing capital expenditures

Another tax minimization strategy used by some businesses is to record capital assets they acquire into expense accounts rather than into asset accounts.  By doing so, they expense 100% of the cash outlay in the year the asset is acquired versus having to depreciate the asset over several years

4.  Improve your inventory accounting system

Yet another area of tax minimization is the handling of inventory.  When the value of inventory is understated, the cost of goods sold is overstated and earnings are thus understated, which negatively affects the business valuation.  Inventory accounting in small businesses is notoriously poor, which represents a significant risk for buyers.  By making improvements in your inventory accounting, you can minimize buyers’ risks while also improving the quality of information which you can use to further improve your business operations.

5.   Track key business metrics

Tracking key business metrics on monthly comparative reports can help spot negative and positive trends and identify opportunities for improvement.  The nature of key business metrics will vary from company to company.  Some common metrics are: leads to close percentages, gross margin percentage, payroll percentage, overhead percentage, average sale, sales by product line, average monthly sales, seasonality percentages, average accounts receivable collection period, average inventory levels and turnover rates, working capital levels, salesperson percentages, bad debt ratio, customer percentages, etc.  To improve your business value, tracking metrics is insufficient by itself.  You must take action to make improvements and then monitor your progress using the metrics.

Prior to selling your business, there is considerable opportunity to increase its value by reviewing and improving your accounting systems and procedures.  In most instances, the further in advance you begin to address these issues, the greater the value improvement opportunity.

Call a business broker for a free consultation. We offer no-charge, no-obligation evaluations of small businesses. We can provide a broker opinion of value and help you identify obstacles to a successful sale as well as opportunities for improvement to increase the value of your business. That is a great way to start planning for a successful and profitable exit from your business.

Seller’s Discretionary Earnings. What are they?

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sellers discretionary earningsWhat are Seller’s Discretionary Earnings (SDE)? The simple explanation is as follows: when you run a business you want to lower your taxable income, as such the owner will legally apply business expenses to their taxable income statement. However, some of these items benefit the owner and thus are discretionary. Items like: the lease of their car, the owners salary, travel and entertainment, etc.

Calculating seller’s discretionary earnings is the first and most crucial step towards setting the selling price of a business or a business valuation. Once you calculate the true owner’s discretionary earnings you apply a sales multiple and you have your price. Sometimes seller’s discretionary earnings is called business re-casted earnings as well. Under either name, it is the basis for sale pricing and of primary interest to buyers.

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