Top 3 SDE Red Flags

Calculating accurate SDE is critical when acquiring a firm. These are some of the most common red flags I see week in and week out. Note: I am in the accounting acquisitions space, but I would assume these could be applied to other industries as well. Brokers and sellers love to pad the numbers. And while some addbacks are legit, others are what I call double dipping. I have a rule: no double dipping. Here are 3 common red flags I look for when analyzing cash flow. 1. Nonrecurring revenue If they had a $50,000 consulting engagement that won’t happen again, it does not belong in your future projections. That revenue is gone. And if it’s gone from the top, we have to figure out how much cash flow is reduced from that revenue reduction as well. 2. Off-books owner salary Some owners pay themselves outside of payroll or the P&L. But then they try to count that money as an addback. If it didn’t show up as an expense, it cannot be added back to increase profit. That is double dipping! 3. No rent charged for owner-owned real estate If the owner owns the building and isn’t charging themselves rent, the P&L looks great. But you won’t get to operate rent-free. Once you take over, that rent needs to be accounted for, and it will lower your cash flow. These are the kinds of things that can make or break a deal. It’s important that you understand what you’re actually buying. Hope this helps.