L-301 · Lesson
Advertised earnings are not the cash you keep
Free Practitioner review pending Reviewed 2026-10-03
The decision
How do I get from the earnings a listing advertises to the cash I could actually keep?
Why this matters
Every listing advertises an earnings figure, and every buyer reads it as a promise: this is what the business makes, so this is roughly what I would make. It is a natural reading and a costly one. The advertised figure answers the seller's question, which is how much a business like this can show. It does not answer yours, which is how much would be left for you.
Between the two there is a ladder. Some of the seller's adjustments will not hold up. The person who does the owner's work may have to be paid. The trucks and machines will wear out. Then come the loan payments, the cash tied up in running the business and tax. Each rung takes something away, and each rung is easy to skip when the number at the top is so inviting.
This lesson shows the ladder in full and teaches you to climb its first rungs with evidence. It also names two labels you will meet constantly, SDE and EBITDA, and says what they do and do not tell you. Stage 3 builds on this picture. If you remember only one thing, remember that advertised earnings are not the cash you keep.
Concept: the ladder from advertised earnings to cash
The rungs
- Advertised earnings
- Add-backs that fail
- Replacement labor
- Equipment allocation
- Debt payments
- Working capital
- Taxes
The first four rungs are the subject of the next three lessons and the Earnings section of the Deal Lab. The last three come after, when you have financing and cash in front of you.
- Advertised earnings are the seller's figure. They are a claim until you rebuild them.
- Add-backs that fail are the seller's adjustments that the evidence does not support. Removing them lowers the figure.
- Replacement labor is the pay for work the seller does and you will not. It lowers the figure again.
- Equipment allocation sets aside money each year for assets that wear out. It lowers the figure to what the Deal Lab calls planning cash.
- Debt payments, working capital and taxes come later. They are real, and they are not in the Earnings section.
Two labels you will meet
Listings and brokers use shorthand for earnings, and two terms cover most of it. Definitions vary between brokers, lenders and sellers, so the first question about any label is what is inside it.
SDE, seller's discretionary earnings, tries to show what a business produces for one owner who works in it. In this school it starts from documented profit before tax and adds back interest, depreciation and amortization, one working owner's pay and benefits that were actually deducted in that profit, and adjustments the evidence supports. One-off income comes out, and recurring costs the books leave out go in. It is not an accounting-standard measure, so ask for a line-by-line reconciliation and do not rely on the label. The result combines the owner's wage and the owner's return into one figure. Owner-operated businesses use it because in a small company there is often no clean line between what the owner is paid and what the business earns.
EBITDA, earnings before interest, taxes, depreciation and amortization, shows what the business produces before financing, tax and accounting for the age of its assets. It is not an accounting-standard measure and it is not operating cash flow. It does not show that management is adequately paid, so look at the pay already recorded. Once further adjustments are made, the result is adjusted EBITDA, and each adjustment should be listed. It is more often quoted for businesses with management in place, where someone has been paid a wage for running them, so it is already after that cost. Lenders often start from it, as the next fact shows for one program.
That is one program and one date, shown here to explain why you will hear the word. For this coverage test, the lender looks at what the business has done, not at what a buyer hopes it will do.
What the two labels share matters more than what separates them. Neither one is cash you can spend. Both are before debt payments, before equipment replacement, before the cash the business needs to run and before tax. And in both, the seller chose what to include. A seller's SDE is not automatically your economic result, because it counts the owner's own pay as available to you and because its add-backs are claims. If you will not do the owner's work yourself, someone must be paid to, and that cost is not in the figure.
Three results that are not the same
The Deal Lab keeps three results apart on purpose.
| Term | What it is | What it still leaves out |
|---|---|---|
| Supported earnings | The business's profit plus only the add-backs that evidence supports | The cost of replacing the owner's labor |
| Normalized buyer earnings | Supported earnings after paying for the work you will not do | Equipment that wears out and everything after it |
| Planning cash | Normalized earnings after setting aside an annual allowance for equipment | Debt payments, working capital, tax |
None of these is cash available to you. That comes after financing and the rest, in the stages ahead. Supported means supported in your own assessment: marking an add-back supported is not a CPA's verification or a lender's acceptance, and a finished checklist is not finished due diligence. Each rung is more honest than the one above, and each is still before something real.
Whose labor
The role you chose in Stage 1 decides how replacement labor works. If you will run the business yourself, the owner's work is yours, and your pay comes out of the same earnings. If you will hire a manager, the manager's cost is a deduction from the business and your income is whatever remains. You cannot count the owner's pay as available for you and also assume you will not do the work. The ladder forces you to say which.
Taxes are a later rung, not a footnote
An owner's earnings are before the tax the owner will pay.
That is one tax on one kind of earnings, quoted so that you see that tax is real. It is not a flat tax on owner cash. Its base, the Social Security limit and any wages you are paid all change the result, and other structures are taxed differently.
Loan principal and an equipment allowance you have not spent do not automatically reduce taxable income. Buyer School shows cash before personal tax unless a result says otherwise, so never compare it directly with an after-tax household budget. A CPA estimates entity, owner, payroll and state taxes for your actual structure. The ladder simply keeps tax visible.
Unknown is not zero
When a rung depends on a number you do not yet have, such as the cost of replacing the owner's work, you cannot write zero. A zero says the cost does not exist. The honest entry is "unknown", and the result above it should say that it may be overstated. The Deal Lab marks a result that leaves out an unknown cost, so that no figure looks final when it is not.
Conclusions go stale
If the evidence changes, the earnings may change. If the earnings change, anything built on them may be out of date. A conclusion is only as current as the assumptions and evidence beneath it, and the Deal Lab tells you when something it computed rests on inputs you have since changed.
Worked example: climbing the first rungs
Illustrative example
This business is fictional and its figures are invented for this lesson.
A landscape company's listing advertises $180,500. The buyer reviews the evidence for two add-backs and plans to hire a manager. Supported earnings are net income plus the add-backs the evidence supports.
The bridge below uses the Deal Lab's own steps. Net income is $104,300. The owner's pay of $67,400 is supported by payroll records. The owner's vehicle of $8,800 is called personal, but there is no log, so it is unsupported. A replacement manager costs $59,500, and the buyer sets aside $13,200 a year for equipment.
Illustrative example: seller to buyer earnings bridge
- Seller's claimed cash flow$180,500
- Less: Owner's vehicle, called personal, not counted Unsupported-$8,800
- Supported earnings, before role costs$171,700
- Less: Replacement manager-$59,500
- Normalized buyer earnings$112,200
- Less: Equipment allocation, each year-$13,200
- Planning cash before debt and owner pay$99,000
Read it from the top. The seller's claim is the longest bar. The buyer removes the add-back that failed, pays for the manager and sets aside for equipment, and arrives at planning cash. Each cut has a reason you could write in one sentence, and none of the reasons is that the seller was dishonest. It is simply what the evidence and the buyer's plan support.
Failure modes
1. Reading advertised earnings as take-home
How it shows up: the figure is compared with household needs as though it were pay. What to do: keep the ladder visible and name the rung you are on.
2. Ignoring whose labor it is
How it shows up: the owner's pay is counted as profit and the buyer plans not to do the work. What to do: decide your role, and pay for any work you will not do.
3. Entering zero for what you do not know
How it shows up: a blank cost is typed as zero so the result looks complete. What to do: write "unknown", and let the result say it may be overstated.
4. Stopping at earnings
How it shows up: the analysis ends at a normalized figure and equipment, debt and working capital are never raised. What to do: list the rungs below where you stopped, and know they are still ahead.
Buyer rules
Buyer rule
Advertised earnings are not the cash you keep. Walk the ladder every time.
Buyer rule
Unknown is not zero. Say what is missing, and say the result may be overstated.
Apply it
- Write the ladder for a business you are interested in, with the advertised figure at the top.
- Name the label the listing uses, SDE, EBITDA or neither, and ask what it includes.
- List the add-backs the seller claims, and mark each as having evidence or not.
- Decide the role you will play, and write the cost of the work you will not do.
- List the equipment that will wear out, and ask an owner how long it lasts.
- Mark the rungs below where you stopped as still ahead, with the tax rung going to your accountant.
Tool: the Earnings section
The Earnings section of the Deal Lab holds the ladder for a business. It records which of the seller's add-backs you support, adds the costs you apply for replacement labor and equipment, and shows the bridge from the seller's figure to planning cash. It does not tell you which add-backs to accept.
The decision it asks of you is the evidence behind each adjustment. Support only what a document supports, and leave the rest unsupported or unresolved. Then look at the bridge and ask, of each step, why it moved. Leave an unknown cost unknown, so the result says it may be overstated.
The output is your Normalized earnings. It is complete when every add-back is classified, which is different from being right: a classification you cannot explain will not survive the next section. The Deal Lab shows this with a business to practice on, and the lessons that follow teach the reasoning behind each choice.
Lesson, then tool, then output
Earnings
You finish this lesson by producing a real output: Normalized earnings. Progress in this school is work you have completed, not pages you have read.
Next decision: Reading the seller's numbers: P&L and tax return
Evidence required
The ladder is built from evidence, so name it at each rung.
- For add-backs, a document that shows the expense existed and why it would not continue.
- For replacement labor, a quote for the role you will not play, from your own market.
- For equipment, the age and condition of what is on the list.
- For anything unknown, the question that would find it out.
A rung with no evidence is not yet a number. It is a to-do.
Decision question: where the advertised figure stops
A listing advertises earnings of $181,000 for a business a buyer plans to run through a hired manager. What is the most accurate description of that figure?
Open each answer to see why it is or is not the stronger one.
The cash the buyer can expect to receive each year
Weaker answer. The figure is before debt, equipment, working capital and tax, so it is not the buyer's cash.
A figure that becomes reliable once the broker confirms it
Weaker answer. A broker's confirmation does not test the add-backs or add the missing costs.
A seller's claim that still counts the owner's pay as available, includes untested add-backs and leaves out the manager, equipment and debt
Defensible answer. Each part of that sentence is a rung of the ladder that the figure skips.
The business's profit after every cost, since a listing must include all costs
Weaker answer. A listing presents whatever the seller chooses, and nothing requires it to include the buyer's costs.
Scenario check
A listing says its earnings are "SDE" and a lender's summary uses "EBITDA" for the same business. What should the buyer do?
Open each answer to see why it is or is not the stronger one.
Use the larger figure, since it shows the business at its best
Weaker answer. The larger figure may rely on more claims. Best is not the same as defensible.
Treat them as the same, since both stand for earnings
Weaker answer. They are built differently, and the difference is the owner's pay.
Ask what each includes, and rebuild one figure from evidence, since the labels differ in whose labor is paid and which add-backs are counted
Defensible answer. The labels describe how a number was built. Comparing them without knowing the inside is guessing.
A buyer will hire a manager but does not yet have a quote, and asks whether to enter zero for replacement labor so the bridge completes. What is the better course?
Open each answer to see why it is or is not the stronger one.
Enter zero and revise later, since a number is better than a blank
Weaker answer. A figure that looks final invites decisions that rest on a cost nobody counted.
Enter the owner's pay, since that is what the job paid before
Weaker answer. The owner's pay is what the seller took, not what replacing the work will cost.
Leave it unknown, and treat the result as potentially overstated until a quote is in
Defensible answer. A zero asserts that the cost does not exist, while unknown admits it has not been found.
A buyer completes the bridge and arrives at planning cash. How should the buyer describe that number?
Open each answer to see why it is or is not the stronger one.
As the cash available to the buyer each year
Weaker answer. It is still before debt, working capital and tax, so it is not the buyer's cash.
As the earnings after support, role cost and an equipment allowance, and still before debt payments, working capital and tax
Defensible answer. Planning cash is further down the ladder and not the end of it.
As the business's value
Weaker answer. It is an earnings figure, and value is a separate question for a later stage.