Discretionary Earnings or DE & EBITDA are common earnings terms used frequently in business sales, but what exactly do these figures mean and how are they calculated?  

Discretionary Earnings Calculation

To calculate Discretionary Earnings (DE) start with Net Profit shown on Federal Tax Return then add Interest, Depreciation, and Amortization plus owner’s benefits and expenses as shown below.  

Net Profit (Federal Tax Return) 

• + Interest Expense

• + Depreciation

• + Amortization 

• + Owner’s compensation (from W2 salary on tax return)*

• + Owner’s benefits such as auto, health insurance, travel/entertainment, and other expenses (non-business expenses and included on the tax return) 

• + One Time & Non-Recurring or Unusual Expenses.  These are added back if they are a one-time extraordinary expense.  

= Discretionary Earnings, aka DE

* Note: Distributions are NOT an add-back for determining Discretionary Earnings.  Distributions are a Balance Sheet transaction and not an expense in the business.  Distributions are from the Net Profit of the business and thus adding back Distributions is effectively double counting.

Normalized EBITDA Calculation

The simplest way to calculate Normalized EBITDA is to start with DE (Discretionary Earnings) and subtract the market value replacement salary for a manager to run the business.  Normalized EBITDA is essentially the earnings of the business under an absentee owner business model.  

To calculate Normalized EBITDA from scratch you would do the following: 

Net Profit (Federal Tax Return) 

• + Interest Expense

• + Depreciation

• + Amortization 

• + Owner’s compensation (from tax return) 

• + Owner’s benefits such as auto, health insurance, travel/entertainment, and other expenses (non-business expenses and included on the tax return) 

• + One Time & Non Recurring or Unusual Expenses.  These are added back if they are a one-time extraordinary expense.  

• – Replacement Salary at market value for a Manager to replace the owner. 

= Normalized EBITDA