How To Calculate Discretionary Earnings

About Discretionary Earnings

Imagine it’s finally time to sell your business. You’ve been waiting for this day. But now what? What do you need to know as the next step in selling your business? Well, finding your Discretionary Earnings (DE) is a huge step. You may be wondering, what are Discretionary Earnings and how do we come up with them? It is no imaginary number, it is a well-intentioned equation.

As a business owner, understand that you are trying to save as much money as you possibly can on your taxes. Your Certified Public Accountant, or CPA, also has the same goal of trying to save you as much as possible on your taxes. What we, as business brokers, are trying to do is work with you to determine how much you’re making from this business. By disentangling the equation that is Discretionary Earnings, we can then present that to a buyer. This way the buyer can look at the DE and say “If the business continues to operate in the same manner, this is how much I can expect to make from this business”.

So what is Discretionary Earnings exactly, and how do we come up with yours?

Your Discretionary Earnings is what we, as business brokers, help you to find for the true earnings of your business. Discretionary Earnings go beyond just your income and net profit. It factors in many other benefits. It is found through an equation of sorts that we’ve created a step-by-step guide for:

Calculating Discretionary Earnings:

  1. Net Profit: First, subtract all of your business’s expenses from the total revenue to determine the net profit.
  2. Owner’s Salary: Then, we add your owner’s salary to the net profit. This is because we can assume that the buyer will become the new owner/operator and take over your salary.
  3. Interest Expense: Next, we add back the interest expense to the net profit as well, usually at 100%.
  4. Non-Cash Expenses: Next, we also add back the depreciation and amortization, as those are non-cash expenses.
  5. Discretionary Expenses: After that, we find the expenses that may not have been necessary to the business. We add that to our equation as well. Examples of these expenses include your health insurance, or your portion of your 401k (if set up through your business), among other expenses not needed for the business.
  6. One-Time or Unusual Expenses: Following your discretionary expenses, we also add back any one-time or unusual expenses. An example of this would be purchasing an air conditioning unit that maybe doesn’t need replacing for many years.
  7. Calculate Discretionary Earnings: Finally, when we’ve added up all of these factors, we get your discretionary earnings.

Discretionary Earnings Equation:

Discretionary Earnings= Net Profit + Owner’s Salary + Interest Expense + Non-Cash Expenses + Discretionary Expenses + One-Time Expenses

Ultimately, understanding and calculating discretionary earnings is essential for the beginning process of selling your business. By taking into account the factors listed above, you’re able to find and optimize the value of your business. As a business broker, our goal is to help our clients navigate the complexities of buying and selling businesses, and a thorough comprehension of Discretionary Earnings is such a valuable tool in this process.

Over my career, I’ve instructed hundreds and hundreds of new brokers on how to calculate Discretionary Earnings. There can be a bountiful amount of what-ifs through the process of finding your Discretionary Earnings. This process has the potential to be complicated, with problems that can range from post-closing to the buyer doing their due diligence to ensure that DE is correct. That is why I suggest you speak with a seasoned business broker to ensure there are no hiccups. Give me a call, and I’ll make sure your Discretionary Earnings are done the right way, at no charge to you and no obligations to use my services.

If I can help you evaluate your company’s worth and marketability, the first step is to schedule a call with me. 

About the author: Jim Parker

Jim Parker is an experienced business broker specializing in small businesses. His company is based in Clermont, Florida. As an industry leader, he has served as the past president of the Business Brokers of Florida and currently sits on the International Business Brokers Association’s Board of Governors. Jim is a sought-after speaker who teaches others in his industry best practices in ethics, closing transactions, and finding qualified buyers. He has earned over 50 awards and recognitions in his career.

Jim is a Certified Business Intermediary (CBI), Certified Mergers and Acquisition Professional (CMAP), Masters Certified Business Intermediary (MCBI), and is a Mergers & Acquisitions Master Intermediary (M&AMI. He is one of less than 20 business intermediaries in the world that have all four of these designations. To contact Jim, give him a call at (407) 927-8999.