How is Seller's Discretionary Earnings (SDE) calculated?

Seller's Discretionary Earnings (SDE) is calculated by including the owner's salary and other add-backs to the business's net profit. This metric is particularly useful for understanding the total financial benefit a business provides to its owner, especially in scenarios such as business valuations or when assessing the profitability of small businesses.

The key components of SDE include the net profit of the business, the owner’s salary, and any discretionary expenses that can be added back to the net profit, such as non-recurring expenses or perks that the owner might be using from the business. This approach gives potential buyers a clearer picture of the company's cash flow and its overall financial health, taking into account the value created for the owner beyond just net profit.

While other methods of calculation in the options may relate to business financials, they don't accurately reflect the specific components that define SDE. Thus, acknowledging the owner's contributions and any discretionary spending is vital for a holistic assessment of earnings that are available to the owner, which is why this method is the correct one for calculating Seller's Discretionary Earnings.