What’s the difference between EBITDA, FCF, and SDE ?
A buyer of a business clearly wants to know how much money they can expect the company to generate annually. In larger transactions (which are generally handled by investment banks such as Quazar Capital Corporation), this amount is often referred to as EBITDA (an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization). EBITDA is regularly used instead of Net Income to evaluate a company’s performance because buyers may ultimately change the company’s capital structure; EBITDA also includes non-cash expenses, which are often accounted for in a variety of ways. For these reasons, EBITDA allows buyers to better compare “apples to apples” when evaluating the financial performance of different companies.
Free Cash Flow (FCF) is another commonly used financial metric. We often hear FCF used interchangeably with EBITDA; however, this usage is incorrect. FCF is generally calculated as: Earnings Before Interest and Taxes (EBIT) x (1-Tax Rate) + Depreciation + Amortization – Capital Expenditures – Change in Net Working Capital. Before you start having panicked flashbacks to math class, the key takeaway from FCF is that it seeks to show how much cash a company has after maintaining or expanding its assets. This is why FCF, unlike EBITDA, subtracts Capital Expenditures (often referred to as “CapEx”) and changes in Net Working Capital.
In the Business Brokerage market, Seller’s Discretionary Earnings (SDE) is most often used to evaluate and value companies. SDE is defined as EBITDA plus one owner’s salary and benefits. In smaller transactions, the owner’s salary and benefits can greatly vary from company to company. Additionally, the owner’s total compensation often comprises a significant percentage of a company’s overall financial performance. For these reasons, in the business brokerage marketplace, SDE is most commonly used to gauge a company’s financial performance.