What are Discretionary Expenses?
The Short Answer
Discretionary Expenses explained simply
Discretionary expenses are costs that a business owner chooses to incur. They are not strictly necessary for the business to run. Think of things like a fancy company car, excessive travel, or non-essential subscriptions. When someone buys a business, these expenses are often "added back" to the net profit. This gives a clearer picture of the business's true earning power for a new owner.
Real-World Example
The Coffee Shop Owner
Imagine a coffee shop owner who pays for their personal car insurance through the business. They also take their family on an annual vacation, expensing it as a "business trip." These are discretionary expenses. If the coffee shop makes $100,000 in net profit, but $15,000 of that was for the car insurance and vacation, a buyer would see the business as actually generating $115,000 in profit if those expenses were removed.
Why this matters
Understanding discretionary expenses is key for valuing a business. By identifying and adding these back, you can see the true profit a business generates. This helps buyers understand what they are really buying and helps sellers justify a higher asking price.
When preparing your business for sale, go through your expenses with a fine-tooth comb. Identify anything that is truly discretionary. Document these clearly so a buyer can easily understand them. This transparency builds trust and helps justify your asking price.
When preparing your business for sale, go through your expenses with a fine-tooth comb. Identify anything that is truly discretionary. Document these clearly so a buyer can easily understand them. This transparency builds trust and helps justify your asking price.
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