SDE vs EBITDA vs Cash Flow: Differences, Formulas & Business Valuation Use

Key Takeaways

• Seller’s Discretionary Earnings (SDE) measures what one working owner takes home, and it prices smaller businesses where the buyer steps in and does the owner’s daily job.
• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) measures what the company earns on its own after paying a manager, and it prices businesses that run without the owner.
• Cash flow tracks money left after replacing trucks and covering unpaid invoices, and unlike the others, it makes no adjustment for owner pay.
• Buyers multiply SDE or EBITDA to reach a price, commonly 2x to 4x EBITDA for a $5 million service business. Cash flow only proves loan repayment ability to a lender.
• Core Growth Group buys HVAC and plumbing companies across the Texas Triangle as a direct strategic buyer, and we consult owners through the twelve-month prep that decides which metric prices their sale.

SDE, EBITDA, & Cash Flow Are Not Interchangeable

SDE, EBITDA, and cash flow answer three different questions about the same business, and the buyer reviewing your financials already knows which one applies. Most owners treat all three as one measure of profit, which is exactly how a business ends up priced off revenue at a number no buyer will meet.

Run EBITDA on an owner-operated company and the figure comes in below SDE, because EBITDA subtracts the cost of a manager to replace you while SDE counts your pay as earnings a buyer keeps. Which metric applies is not a choice you make. It follows from your business size and how much of the daily work runs without you.

At Core Growth Group, we buy HVAC and plumbing companies across the Texas Triangle as an operator-led buyer, not a broker or private equity firm. We also consult with owners on the preparation that decides which of these numbers a buyer uses, and what that number lands at.

What Is SDE (Seller’s Discretionary Earnings)?

Seller’s Discretionary Earnings represents the total financial benefit one working owner receives from operating the business full-time. It assumes the buyer steps into the owner’s role and takes over the day-to-day work. SDE is the standard metric for smaller businesses, generally those producing under $1 million in annual earnings.

The SDE Formula

SDE = Pre-Tax Net Profit + Owner’s Compensation + Add-Backs

Start with pre-tax net profit. Add back the owner’s salary and benefits, since a buyer will pay themselves out of the same earnings. 

Then add discretionary or one-time expenses that ran through the business: a personal vehicle, an owner’s travel, a non-recurring legal bill, family members on payroll who do not perform a market-rate function.

The result is a normalized figure showing what the business produces for the person running it. Every add-back needs documentation. Anything you cannot support in your books will be challenged in diligence and stripped back out.

Which Businesses Get Valued on SDE

Owner-operated companies where the buyer directly replaces the seller. Local trades businesses, independent shops, professional practices, and single-location operators. 

In plumbing and HVAC specifically, this covers most companies under roughly $3 million in revenue where the owner still runs dispatch, quotes the larger jobs, or works in the field.

What Is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It does not assume the buyer will run the business personally. It measures the earnings power of the company as a standalone enterprise, separate from how it is financed, where it is taxed, and what it has historically spent on assets.

The EBITDA Formula Explained

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Or, working from the operating line:

EBITDA = Operating Income (EBIT) + Depreciation + Amortization

Both arrive at the same figure. Buyers also work with Adjusted EBITDA, which applies add-backs similar to SDE by removing one-time expenses, owner perks, and non-recurring revenue events to reach a clean picture of normalized earnings. This is the number that most often drives a mid-market service business valuation.

Why EBITDA Excludes Non-Cash & Financing Costs

Depreciation and amortization reduce reported profit on paper without moving any cash out of the business. Interest depends on how the current owner chose to borrow. 

Taxes depend on entity structure and jurisdiction. Removing all four produces a figure that compares two companies on operating performance alone, independent of financing decisions neither buyer nor seller intends to carry forward.

What Types of Businesses Use EBITDA

EBITDA is the standard valuation metric for mid-market businesses, typically those earning more than $1 million to $2 million a year. It is the language of private equity, investment banks, and institutional lenders. 

If a business has a management team in place and does not depend on a single owner-operator, EBITDA is almost always the appropriate metric.

What Is Cash Flow in Business Valuation?

Where EBITDA stops at operating earnings, cash flow accounts for the actual demands on capital: equipment purchases, debt repayments, and changes in working capital that affect how much money is available to the owner or investor. 

Operating Cash Flow (OCF) 

OCF = Net Income + Non-Cash Charges − Increase in Working Capital

This measures cash generated from core operations. Take net income, add back non-cash charges like depreciation, then adjust for changes in working capital including accounts receivable, inventory, and accounts payable.

Free Cash Flow (FCF) 

FCF = Operating Cash Flow − Capital Expenditures

FCF subtracts capital expenditures from operating cash flow, revealing what remains after keeping the business running and maintained. For asset-heavy businesses, the difference between EBITDA and free cash flow can be substantial. 

How Cash Flow Differs From Profit

Profit records revenue minus expenses as they are booked. Cash flow tracks money as it moves. 

The two diverge when timing differs from recording, which is why a business can post a profitable year while running short on cash: long payment terms to commercial customers, inventory buildup, or heavy debt service. 

For a buyer, cash flow is the more reliable indicator of what the business will produce. 

When Buyers & Lenders Use Cash Flow

Cash flow comes up once the price is set and a buyer goes to arrange financing. Lenders start from EBITDA, then subtract equipment spending and the money an owner takes out of the business before testing the loan against what remains.

SDE vs EBITDA  vs Cash Flow: Key Differences

Owner Compensation Treatment

SDE adds the owner’s compensation back into earnings. A buyer who plans to run the business will pay themselves instead of the seller, so the seller’s pay is money available to the new owner. 

Adjusted EBITDA assumes a hired manager will run the company, so a market-rate management salary stays in operating expenses. Owner pay above that amount gets added back. Owner pay below it gets deducted, putting Adjusted EBITDA under the profit the books show.

Cash flow makes no adjustment for owner pay. It begins with net income, so whatever the owner took stays subtracted, since cash flow measures money that moved.

Business Size & Earnings Thresholds

Businesses with SDE under roughly $1 million are valued on SDE multiples, and businesses above that move toward EBITDA. Plenty of companies between $3 million and $6 million in revenue could be priced either way, and the deciding factor is usually how much of the operation runs without the owner.

For service companies around $5 million in revenue, EBITDA multiples commonly run between 2x and 4x, with roughly 3x as a baseline. Consistent year-over-year growth of 20% to 30% supports the upper end, which materially changes what you take home at closing.

Cash flow has no size threshold. A $2 million plumbing company and a $40 million one both get measured against it. What raises its importance is asset intensity, existing debt, and growth speed, not the size of the earnings figure.

SDE vs EBITDA vs Cash Flow: Comparison Table

	SDE	EBITDA	Cash Flow
What it measures	What one working owner earns from the business	What the business earns on its own, with a manager in charge	How much cash is left after the business pays for trucks, equipment, and unpaid invoices
Formula	Pre-Tax Net Profit + Owner’s Compensation + Add-Backs	Net Income + Interest + Taxes + Depreciation + Amortization	OCF = Net Income + Non-Cash Charges − Increase in Working Capital FCF = OCF − Capital Expenditures
How owner pay is handled	Counted as earnings, all of it	A manager’s salary stays in the costs	Stays in the costs, unchanged
Fits businesses where	The owner still works in the business every day	A manager or team runs daily operations	Applies to every business
Typical earnings size	Under $1 million a year	Above $1 million to $2 million a year	Any size
Used by	Individual buyers	Private equity firms, acquirers, and banks	Lenders and any buyer using a loan

How Can Core Growth Group Help?

SDE, EBITDA, and cash flow describe one business in three numbers, and each exists for a different reason. Knowing which applies to your company tells you which buyers will look and what a serious offer should contain. Price off revenue instead of earnings, and you start with a number that draws only silence.

At Core Growth Group, we prepare HVAC and plumbing owners for sale by getting the right earnings figure documented and defensible, usually across about twelve months. We read those numbers the way a buyer will, because we buy service businesses across the Texas Triangle ourselves, and we also work with owners on growing or exiting when that fits their stage. Start a conversation with us. 

Frequently Asked Questions (FAQs)

What is the main difference between SDE and EBITDA?

SDE adds the owner’s full compensation back into earnings, since a buyer stepping into the role captures that money themselves. Adjusted EBITDA keeps a market-rate manager’s salary in the costs and adjusts only the difference between that figure and what the owner actually took.

Can a business use both SDE and EBITDA for valuation?

Yes, and many sellers calculate both. Companies earning between $1 million and $2 million a year fall between the two metrics, so either one could reasonably apply. Running both numbers prepares you for buyers who work in SDE and buyers who work in EBITDA.

Is EBITDA the same as operating cash flow?

No. EBITDA stops at operating earnings, while operating cash flow also accounts for taxes paid and money tied up in receivables, inventory, and payables. A growing business can post strong EBITDA and weak operating cash flow at the same time, and free cash flow falls lower still once truck and equipment replacement is deducted.

How can I increase my SDE or EBITDA before selling?

Clean financials and documented add-backs recover value you have already earned but cannot currently prove. Building a management layer that runs daily operations without you moves the business toward EBITDA pricing and a wider buyer pool. Most owners need about twelve months to do both properly.

Why do buyers care which metric is used?

The metric a buyer chooses tells you how they price the risk in your business, and owner dependence is the largest part of that. We are on the buying side of these transactions at Core Growth Group, so we approach your numbers the way the next buyer will. Reducing that dependence is what our preparation work targets: systems, financial preparation, and stress testing, typically over about twelve months.

 

*Disclaimer: This content is for informational purposes only and should not be considered business, financial, legal, or tax advice. Results vary based on market conditions and individual business circumstances. To learn more about scaling, preparing, or exiting your business, visit Core Growth Group.