Having been a business broker for 31 years, I have had to explain to my clients that owner distributions are not included in SDCF (Seller’s Discretionary Cash Flow).
For many clients they are not sure why owner distributions are not included in SDCF and have asked me to provide an explanation. I initially tell them that theoretically an owner distribution either comes from prior period or current period earnings or another source of cash. A buyer wants to know what they can realize from the business, and they use the income statement as the basis for their analysis.
I have come up with an example to explain this concept to my clients:
- Suppose it is day 1 of a new business, and the owner goes to the bank to borrow $100,000 for working capital. When that money is deposited into the checking account, it is a debit to CASH for $100,000 and a credit to Loans Payable – Bank for $100,000.
- If the owner then writes himself a check for $50,000 and calls it a distribution, it is a credit to CASH for $50,000 and a debit to DISTRIBUTIONS for $50,000. The Balance Sheet then appears as CASH – $50,000: Loans Payable – Bank – $100,000 and Distributions – $50,000. The Income Statement appears as SALES – $0.00; COST OF GOODS SOLD – $0.00; GROSS PROFIT – $0.00; EXPENSES – $0.00 and NET INCOME – $0.00.
I then ask my client. “Do you feel that the buyer will accept that SDCF is $50,000 just because the owner wrote himself a check in that amount?” How the funds are used is irrelevant. In this example, the business has made nothing year-to-date, and the SDCF is clearly $0.00.
If they still don’t get it after my example, I simply say, “Let’s agree to disagree, and we will see what buyers have to say.”
Hope this example helps with understanding why owner distributions are not included in SDCF.
Article by: Loren Marc Schmerler, CPC, APC and President/Founder of Bottom Line Management, Inc. and an expert Business Broker/Business Intermediary.