Ask two owners what their businesses earn and you may get two numbers that are not comparable at all. One quotes revenue. The other quotes net income. A buyer, meanwhile, is calculating something else entirely — and applying a multiple to it.
Understanding which earnings measure applies to a transaction, and why, is one of the most useful things an owner or buyer can learn before a negotiation begins.
Revenue is not profit, and profit is not one number
Revenue is what comes in the door. Profit is what remains after the costs of generating it. But "profit" has several definitions, and each answers a different question:
- Net income is the accounting bottom line — revenue minus all expenses, including interest, taxes, depreciation, and amortization. It reflects financing choices and accounting conventions as much as operations.
- EBITDA — earnings before interest, taxes, depreciation, and amortization — strips out financing structure and non-cash accounting charges to approximate the operating performance of the business itself.
- Adjusted EBITDA goes further, removing expenses that are unusual, one-time, or not expected to continue under new ownership — and adding costs that should be there but are not.
- Seller's Discretionary Earnings (SDE) is common in smaller, owner-operated businesses. It starts from operating earnings and adds back the full compensation and discretionary benefits of the owner, on the theory that a buyer who will work in the business receives both the profit and the owner's salary.
Each measure is legitimate. Problems arise when they are confused with one another.
What counts as a real add-back
An add-back is an expense in the financial statements that a buyer reasonably would not expect to continue. Legitimate examples include a one-time legal settlement, the owner's personal vehicle expenses, or above-market rent paid to a related entity that will be renegotiated.
Not every expense qualifies. Repairs that recur every few years are not one-time. Marketing that generated the revenue is not discretionary. Add-backs that cannot be explained and documented tend to be rejected in diligence — and each rejected add-back erodes the credibility of the rest.
The replacement labor question
Here is the distinction that most often separates SDE from adjusted EBITDA. If the owner works in the business, someone must do that work after the sale. SDE assumes the buyer does it personally and pockets the owner's compensation. Adjusted EBITDA assumes a hired manager does it — and deducts a market salary for that manager.
A business cannot fairly claim both. An owner who wants credit for stepping away must also accept the cost of being replaced.
A hypothetical example
Consider a hypothetical services business — the numbers are illustrative, not drawn from any real company. Its tax return shows net income of $185,000. Behind that number:
| Item | Amount |
|---|---|
| Reported net income | $185,000 |
| Interest expense | $22,000 |
| Depreciation | $38,000 |
| One-time legal matter | $15,000 |
| EBITDA, adjusted for the one-time item | $260,000 |
| Less: market salary for a replacement manager | ($85,000) |
| Adjusted EBITDA | $175,000 |
The same business on an SDE basis: take the $260,000 adjusted figure, add back the owner's total compensation of $120,000 and personal vehicle expenses of $9,000, and SDE arrives at $389,000 — before any replacement-labor deduction, because SDE assumes the buyer steps into the owner's role.
Now the multiple question. If businesses like this hypothetically trade around 4.0 times adjusted EBITDA, the estimate is roughly $700,000. If they trade around 2.6 times SDE, the estimate is roughly $1,011,000. Neither figure is wrong — but they are not interchangeable, and mixing an SDE multiple with an EBITDA figure (or the reverse) produces nonsense. Multiples also vary widely with size, industry, growth, customer concentration, and deal structure, and any calculated estimate is a starting point for discussion, not a guaranteed sale price.
Sustainable versus nonrecurring earnings
One more distinction deserves its own moment: whether the earnings themselves will repeat. A business that landed one enormous project last year has higher reported profit than a business with steady, unglamorous, recurring revenue — and may be worth less. Buyers adjust for this instinctively. They look at several years of results, ask what drove the best ones, and mentally remove whatever they believe will not continue under their ownership. Sellers do themselves a favor by making that adjustment first, honestly, before a buyer does it skeptically.
Why buyers examine earnings quality
Two businesses can report the same profit and deserve very different prices. One earns its profit from a diversified customer base on recurring contracts; the other from two large customers who could leave. One's earnings grew steadily; the other's spiked on a single project. Buyers are not buying last year's number. They are buying their confidence that the number will repeat.
The RANGEFINDER Perspective
The goal of earnings analysis is not to make the number larger. It is to understand which earnings a buyer can reasonably expect to continue — because that is the number the market will actually price.
Curious what your own earnings might look like through this lens? Explore the Business Valuation Calculator — an educational tool that walks through normalization, add-backs, and user-selected multiples step by step.