Seller's Discretionary Cash Flow
Putting it all together
Seller’s discretionary cash flow is probably the best measure of profitability for the purpose of evaluating the financial performance of small businesses and is a concept that is used extensively throughout the field of business brokerage and business valuation.
For those unfamiliar with this particular performance measurement, it is determined by adding to pre-tax net profit the wages for one principal owner/manager (or salaried manager) including bonuses and any personal insurance premiums paid through the business.
To this total is added the non-cash expenses of depreciation and amortization plus all interest paid on long-term debt. Additionally included are all expenses not necessary for the operation of the business generally categorized as “owner perquisites” which typically include such things like the owner’s personal auto expenses, travel and entertainment and so forth enjoyed by all of the owners and their family members.
If the business pays a wage to other working owners or members of the owner’s family, only that portion of their wages and benefits exceeding fair market value (i.e., the amount necessary to attract and hold a non-owner employee to do the same job) is to be included in the definition of seller’s discretionary cash flow. Likewise, if additional owners or their family members are paid something less than a fair market value wage, then the difference between a fair market value wage and what they are actually paid must be subtracted from the total.
And finally, any non-recurring expenses (not capital expenditures) such as a onetime uninsured loss, an extraordinary repair expense and costs of that nature should be added to the total and non-recurring earnings subtracted.)