What is Seller's Discretionary Income ...
In the purchase or sale of a small business we generally come across a term know as Seller's or Owner Operator(s) discretionary income.
Seller’s discretionary income is probably the best measure of profitability for the purpose of evaluating the financial performance of small businesses and is a concept that is used extensively throughout the field of business brokerage and business valuation. This measure allows for business buyers to make an apple to apple comparison whilst eliminating the noise that can distort the financials.
For those unfamiliar with, how is Seller's Discretionary Income calculated, it is determined by adding to pre-tax net profit the wages for principal owner/manager (or salaried manager) including bonuses and any personal insurance premiums paid through the business. To this total, is added the non-cash expenses of depreciation and amortization plus all interest paid on long-term debt. Additionally included are all expenses not necessary for the operation of the business generally categorized as “owner discretionary expenses” which typically include such things like the owner’s personal auto expenses, travel and entertainment and so forth enjoyed by all of the owners and their family members. If there are any non-recurring expenses (not capital expenditures) such as a one time uninsured loss, an extraordinary repair expense and costs of that nature should be added to the total and any non-recurring earnings should be subtracted.