What is Weighted Average SDE?
The Short Answer
Weighted Average SDE explained simply
Weighted Average SDE (Seller's Discretionary Earnings) is a calculation that helps buyers and sellers understand a business's true profitability. Instead of just taking a simple average of SDE over several years, this method assigns different "weights" to each year. Typically, more recent years are given a higher weight because they better reflect the business's current performance and future potential. This approach provides a more realistic picture of what a buyer can expect to earn from the business going forward.
Real-World Example
The Coffee Shop Calculation
Imagine a coffee shop with the following SDE over three years:
- Year 1 (3 years ago): $80,000
- Year 2 (2 years ago): $90,000
- Year 3 (Last year): $110,000
If we use a simple average, the SDE would be ($80,000 + $90,000 + $110,000) / 3 = $93,333.
Now, let's apply weights. We'll give the most recent year (Year 3) a weight of 3, Year 2 a weight of 2, and Year 1 a weight of 1.
- (Year 1 SDE * Weight 1) + (Year 2 SDE * Weight 2) + (Year 3 SDE * Weight 3)
- ($80,000 * 1) + ($90,000 * 2) + ($110,000 * 3)
- $80,000 + $180,000 + $330,000 = $590,000
Next, divide this total by the sum of the weights (1 + 2 + 3 = 6):
- $590,000 / 6 = $98,333
The Weighted Average SDE of $98,333 is higher than the simple average. This shows that the business is growing and its recent performance is stronger.
Why this matters
Weighted Average SDE matters because it gives a more accurate view of a business's current earning power. Buyers often look at this to project future profits. For sellers, it can help justify a higher asking price if their business has been growing recently.
When valuing a business, always look at the trend of SDE. A weighted average helps highlight if the business is on an upward or downward trajectory, which is key for buyers.
When valuing a business, always look at the trend of SDE. A weighted average helps highlight if the business is on an upward or downward trajectory, which is key for buyers.
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