How to Calculate Seller's Discretionary Earnings: A Complete Walkthrough

If you're thinking about selling your business, you've probably encountered the term "Seller's Discretionary Earnings" or SDE. It's the number that drives most small business valuations, but the calculation isn't always straightforward.

In this guide, we'll walk through a real-world example step by step, showing exactly how to normalize your financial statements and arrive at an accurate SDE figure.

What is Seller's Discretionary Earnings?

SDE represents the total financial benefit a single owner-operator can expect to receive from the business. It starts with net income and adjusts for expenses that won't apply to a new owner—while also accounting for costs a new owner should anticipate.

That last part is important. SDE isn't just about adding things back. Sometimes you need to subtract costs that aren't on the books but that a buyer should realistically expect. We'll show both in this walkthrough.

The Case Study: Sunny Plaza Laundromat

Sunny Plaza is a coin-operated laundromat that's been running in a busy strip mall for 20 years. The current owner works about 10 hours per week, primarily overseeing a full-time manager who's been with the business for 15 years. The owner's wife handles the bookkeeping.

The business has 10 washers and 10 dryers, all coin-operated and roughly 10 years old. The dryers have another decade of useful life, but the washers will need replacement in the next 3-5 years. Revenue has grown steadily, the books are clean, and the lease has 5 years remaining with a renewal option.

Here's what the financials look like:

Income Statement (2022-2025)

At first glance, a buyer might look at $72,400 in net income and question whether this business is worth pursuing. But net income tells a misleading story. Let's normalize it.

The Add-Backs: What Gets Added and Why

1. Owner's Salary: $40,000

This is the most straightforward add-back. The owner pays himself a salary, but a new owner would receive this same compensation. It goes back into SDE.

Add-back: $40,000

2. Wife's Bookkeeping Salary: $30,000 (Partial)

The owner's wife is paid $40,000 annually for bookkeeping. But here's the question a buyer will ask: what would it actually cost to have this work done?

Part-time bookkeeping for a simple cash business like a laundromat runs approximately $10,000 per year. The remaining $30,000 is effectively additional owner compensation flowing to a family member.

Add-back: $30,000 (the amount above market rate)

3. Vehicle Expense: $4,200

The owner runs a personal vehicle through the business. Unless the buyer plans to do the same, this expense disappears after the sale.

Add-back: $4,200

4. Cell Phone: $1,200

Same logic as the vehicle. Personal expense run through the business.

Add-back: $1,200

5. Charitable Donations: $2,000

The owner donates to local community initiatives. This is a discretionary expense that reflects the current owner's values, not a business necessity. A new owner can choose whether to continue this.

Add-back: $2,000

6. Interest Expense: $2,200

Interest on business loans is a financing decision, not an operating expense. A new buyer will arrange their own financing with different terms. Interest always gets added back.

Add-back: $2,200

7. Repairs & Maintenance: $9,500 (Partial)

This one requires judgment. Look at the repair costs over four years:

• 2022: $3,000
• 2023: $12,000
• 2024: $4,000
• 2025: $13,000

The spikes in 2023 and 2025 reflect major equipment repairs on aging machines. But a new owner will face repair costs too—you can't assume they'll be zero.

Here's how we handle this: determine a reasonable baseline for ongoing maintenance. For a laundromat this size with 10-year-old equipment, routine maintenance runs approximately $3,500 annually. We add back only the amount above that baseline.

2025 calculation: $13,000 actual − $3,500 baseline = $9,500 add-back

This approach is more defensible than adding back the full amount. You're acknowledging that repair costs exist while normalizing for the unusual spikes.

The Reduction: Costs a New Owner Should Anticipate

Here's where many SDE calculations fall short. They focus only on add-backs and ignore future costs that don't appear on the current financials.

Equipment Replacement Reserve: $10,000

The washers are 10 years old and will need replacement within 3-5 years. Ten commercial washers at approximately $5,000 each means $50,000 in capital expenditures on the horizon.

A prudent buyer should be setting aside money for this. Spread over 5 years, that's $10,000 annually that should be reserved from earnings.

This cost doesn't appear anywhere on the income statement. But it's real, and ignoring it overstates what a new owner can actually expect to pocket.

Reduction: $10,000

Calculating the Normalized SDE

Now we put it together for 2025:

Net Income	$72,400
Add-Backs
+ Owner Salary	$40,000
+ Wife Salary (above market)	$30,000
+ Vehicle Expense	$4,200
+ Cell Phone	$1,200
+ Donations	$2,000
+ Interest Expense	$2,200
+ Repairs (above baseline)	$9,500
Reductions
− Equipment Replacement Reserve	$10,000
Seller's Discretionary Earnings	$151,500

That's a very different picture than the $72,400 net income we started with—but it's also more honest than simply adding everything back without accounting for future costs.

Here's the SDE across all four years:

Year	Net Income	Add-Backs	Reductions	SDE
2025	$72,400	$89,100	$10,000	$151,500
2024	$67,400	$80,000	$10,000	$137,400
2023	$46,200	$88,500	$10,000	$124,700
2022	$40,600	$80,400	$10,000	$111,000

What These Numbers Tell Us

A few observations a buyer or broker would note:

Consistent growth. SDE has increased from $111,000 to $151,500 over four years—roughly 36% growth, or about 8-9% annually. This is a healthy, stable trajectory.

The adjustments are significant. A large portion of SDE comes from normalization adjustments. This is common in owner-operated businesses where the owner and family members are compensated through a mix of salary, benefits, and expenses run through the business.

The business runs without the owner. The owner works 10 hours per week. The full-time manager handles day-to-day operations. This is a semi-absentee business, which typically commands a premium in the market.

The reduction is disclosed. By including the equipment replacement reserve, this SDE figure is defensible. A buyer can't come back later and say "you didn't account for the aging washers." It's already in the number.

What Comes Next

Calculating SDE is step one. The next step is applying an appropriate industry multiple to arrive at a valuation range. Laundromats typically trade between 2.0x and 3.5x SDE depending on factors like location, lease terms, equipment condition, and owner involvement.

We cover that calculation in detail in our next guide: From SDE to Valuation: How to Apply Industry Multiples.