Discretionary Earnings or DE is the total economic benefit the owner derives from the business. This includes the owner’s salary, benefits, and personal expenses that are run through the business. DE is very important as it is used to determine the market value of the business.
To calculate DE start with the Net Profit shown on the business Tax Returns and then add back the owner’s salary and all benefits. Note that all owner’s benefits and expenses must be shown as an expense line item on the company tax return. It need not be a separate line item, but the expense must be included in one of the expense line items on the corporate or company tax return.
Verifying these expenses is done during Due Diligence after an offer has been accepted.
DE is used in most valuation methods including by SBA lenders. EBITDA (Earnings before Interest Taxes Depreciation and Amortization) is also used in valuations, the difference between the two is that DE includes the owner’s salary and EBITDA has a manager’s salary included in the company expenses. Thus valuation multiples for DE are lower than those for EBITA as the DE multiple is applied to a larger earnings figure and EBITDA multiples are applied to much lower earnings figures. The result is generally close if the earnings are calculated correctly.