Reading seller financials like a buyer

P&L vs. tax return vs. SDE — why brokers lead with SDE, and what it hides

Every listing you'll see leads with seller's discretionary earnings (SDE), not net income. SDE starts from the P&L's bottom line and adds back owner's salary, personal expenses run through the business, one-time costs, and non-cash items like depreciation — the idea being "what would this business actually generate for one owner-operator, before their own pay." It's a legitimate concept, and it's the number both lenders and buyers use to size a deal.

It's also the number a broker has the most incentive to maximize, since price is typically quoted as a multiple of SDE. The P&L you're handed in a CIM has usually already been through that adjustment process — what you're looking at as "cash flow" is a broker-prepared number, not the raw output of the seller's bookkeeping software.

Tax returns are the reality check. They show what the business actually reported to the IRS, before any add-backs. If net income from the return, plus the same add-backs the broker claims, doesn't land close to the CIM's advertised SDE, that gap needs a clear explanation before you take the number seriously — see the diligence guide on reconciling tax returns to the P&L for how a full reconciliation works once you're further along.

Normalizing add-backs yourself before you're under LOI

A full quality of earnings (QoE) review is expensive and only happens once you're serious and under LOI — but you don't need to wait until then to sanity-check the biggest add-backs yourself. Before you make an offer, walk the CIM's add-back list line by line and ask, for each one: is this genuinely one-time or outside normal operations, and is there a documented, verifiable cause behind it.

The places brokers get generous most often: family salaries added back in full when the role still needs to be filled by someone, at some real cost; vehicle, travel, or entertainment expenses added back in full when part of the spending was plausibly business use; "one-time" legal or repair costs that actually recur every year or two; and rent add-backs when the owner also owns the real estate and charges below (or above) market rate.

You don't need CPA-level precision at this stage — you need an adjusted SDE you trust enough to make an offer against, and a short list of the two or three add-backs you'd push hardest on once you're in diligence.

Red flags that should change your offer, not just your diligence list

Some issues are pure diligence items — things to verify before closing that don't necessarily change what you're willing to pay. Others are structural enough that they should change your offer or your multiple immediately, because no amount of diligence explains them away:

Revenue trending down over the two most recent years, even if this year's number is flattered by a one-time bump. Customer concentration high enough that one departure would materially move SDE. An adjusted SDE that's grown mostly through an expanding add-back list each year rather than through the business's actual results — a sign the broker or seller is getting more aggressive over time, not that the business is getting stronger. A gap between the tax returns and the CIM's P&L that the seller can't reconcile with a clear, verifiable explanation.

Any of these should move your offer price or your walk-away threshold at the LOI stage, not just get filed away as "confirm during diligence."

How this feeds into the SBA loan and DSCR math later

Whatever adjusted SDE you land on isn't just an internal sanity check — it's the number your SBA lender will independently recompute during underwriting, usually more conservatively than the broker's CIM. Debt service coverage ratio (DSCR), the metric a lender actually uses to decide whether the deal cash-flows, is calculated against adjusted SDE minus your own compensation, not the broker's headline number (see the DSCR guide for the full calculation).

If your own back-of-envelope adjusted SDE is meaningfully below what the listing advertises, that's worth knowing before you make an offer — not after you're under LOI and the lender's number comes back lower than what you underwrote to. See the SBA 7(a) basics guide for how a low appraisal or a financials mismatch stalls a deal already in underwriting.