SDE vs. Cash Flow: What's the Difference and Why It Matters

Business owners use "SDE" and "cash flow" interchangeably all the time. They're not the same thing — and confusing them can cost you real money on either side of a deal.

Here's how they relate, where they diverge, and what it means in practice.

Quick Definitions

Cash flow is the actual money moving in and out of the business. It's what hits your bank account. Positive cash flow means more money comes in than goes out. Negative means the opposite.

Seller's Discretionary Earnings (SDE) is a normalized profitability metric. It takes net income and adds back the owner's salary, personal expenses, interest, depreciation, and one-time costs to show the total financial benefit available to a single owner-operator.

The key difference: cash flow is what actually happened. SDE is what the business can theoretically deliver to an owner.

Where They Overlap

Both SDE and cash flow try to answer the same fundamental question: how much money does this business produce?

For a well-run business with clean books, stable operations, and an owner who takes a consistent salary, SDE and operating cash flow will be in the same ballpark. They're measuring the same underlying economic engine — just from different angles.

If your business generates $300K in SDE and you're seeing roughly $280K-$320K in free cash available each year, things are tracking. The numbers tell a consistent story, and buyers will feel confident.

Where They Diverge — And Why It Matters

The problems start when SDE and actual cash flow tell different stories.

SDE Is Higher Than Cash Flow

This is the more common scenario. Your SDE calculation might show $400K, but your bank account tells a different story. Common reasons:

Receivables are growing. You've booked the revenue but haven't collected it. SDE counts it. Your bank account doesn't.

Working capital is absorbing cash. As you grow, you need more inventory, more receivables financing, more upfront costs. SDE doesn't capture this cash consumption.

Capital expenditures. SDE adds back depreciation (a non-cash expense), but the equipment still needs to be replaced. If you're spending $50K/year on equipment, that cash is gone — even though SDE doesn't reflect it.

Deferred maintenance. You can inflate SDE short-term by not replacing equipment, skipping maintenance, or cutting back on marketing. Cash flow looks fine today, but you're borrowing from the future.

A buyer who focuses only on SDE without understanding cash flow dynamics might overpay for a business that requires significant ongoing capital investment or has collection problems.

Cash Flow Is Higher Than SDE

Less common, but it happens:

Prepaid revenue. Customers paying in advance (annual contracts, deposits) means cash is in the bank before you've earned it.

Inventory reduction. Selling down inventory generates cash without increasing SDE.

One-time cash events. Selling an asset, receiving an insurance payout, or collecting on an old receivable boosts cash without affecting normalized SDE.

These situations usually self-correct, but they can make a business look more cash-rich than its ongoing operations actually support.

What Buyers Are Really Looking At

Smart buyers analyze both SDE and cash flow — and they pay close attention to the gap between them.

SDE tells them what the business earns. It's the basis for the valuation multiple: $300K SDE × 3x = $900K asking price.

Cash flow tells them what the business can service. A buyer financing $700K at 8% over 10 years needs roughly $102K/year in debt service. They also need to pay themselves, fund working capital, and maintain equipment. If the actual cash flow doesn't support all of that, the deal doesn't work — regardless of what SDE says.

Here's the math buyers are running:

If that $78K is consistent with what the business actually produces in cash — after paying bills, collecting receivables, and maintaining equipment — the deal makes sense. If the bank statements show $40K in actual free cash, there's a problem.

How to Close the Gap Before Selling

If you're planning to sell in the next 1-3 years, start aligning your SDE story with your cash flow reality.

Tighten up collections. Get your accounts receivable current. Every dollar in AR is a dollar that's not in the bank — and buyers will notice the gap.

Stabilize working capital. Stop the cycle of feast-and-famine inventory purchases. Build predictable ordering patterns that match demand.

Invest in maintenance. Replacing equipment before it fails shows buyers that the cash flow is sustainable, not propped up by deferred spending.

Show consistency. Three years of cash flow that consistently tracks close to SDE tells a powerful story. One year of high SDE with erratic cash flow raises questions.

Document capital requirements. If the business needs $40K/year in equipment replacement, own that number. Buyers will discover it in diligence anyway — it's better to present it upfront and build it into your narrative.

The Seller's Trap

The most common mistake sellers make is maximizing SDE through aggressive add-backs while ignoring what the cash flow actually looks like.

You can technically add back that $60K salary you pay your spouse. But if your spouse actually manages the office and a buyer would need to hire a $45K office manager to replace them, your SDE is $15K more defensible — not $60K.

You can add back depreciation. But if your trucks are falling apart and a buyer needs to spend $80K in year one to replace them, the cash flow story doesn't match.

Buyers — especially experienced ones — will reconcile your SDE with your bank statements, your tax returns, and your equipment condition. The businesses that sell for the best multiples are the ones where every number tells the same story.

The Bottom Line

SDE is how businesses get valued. Cash flow is how businesses get bought. The closer those two numbers track, the faster and smoother your deal will go.

If there's a significant gap between your SDE and your actual cash flow, figure out why before you go to market. Either the SDE is overstated (and you need to adjust expectations) or the cash flow has fixable problems (and you should fix them first).

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Want to understand how your SDE and cash flow stack up? Use our valuation calculator to start, or schedule a conversation to walk through your numbers.