How do I assess the true profitability of a business for sale?
Seller-reported profits almost never match what you’ll actually earn as the new owner. Sellers present “adjusted” or “normalized” financials that add back expenses to make profitability look better. Some of those adjustments are legitimate. Others are wishful thinking.
The standard metric for small business sales is Seller Discretionary Earnings, or SDE. This takes reported net income and adds back the owner’s salary, personal expenses run through the business, one-time costs, and non-cash items like depreciation. A business showing $50,000 in net profit might have $150,000 in SDE once you account for the owner paying themselves $80,000 and running their car payment through the company.
Your job is to verify every adjustment. Ask for supporting documentation. If they claim $15,000 in one-time legal fees, you should see the invoices. If they’re adding back $20,000 in “personal travel,” confirm it wasn’t client entertainment that you’ll need to continue. Sellers are motivated to inflate SDE because it directly affects the sale price.
Compare the financials to tax returns. Sellers sometimes show buyers a version of the books that doesn’t match what they reported to the IRS. If the internal P&L shows $400,000 in revenue but the tax return shows $320,000, you have a problem. Either they’re underreporting income to the IRS or inflating it for you. Neither is good.
Pull bank statements and reconcile them against reported revenue. Cash-heavy businesses are especially risky because cash can disappear between the register and the bank. If the seller claims a lot of cash transactions, you have limited ability to verify those numbers.
Look at trends over at least three years. A single profitable year doesn’t tell you much. Is revenue growing, flat, or declining? Are margins improving or eroding? A business that made $100,000 this year but made $150,000 two years ago has a different trajectory than one that’s grown consistently.
Watch for customer concentration. If 40% of revenue comes from one client, you’re buying a business where losing that relationship cuts your income nearly in half. The same applies to key employees or vendor relationships that might not survive the ownership transition.
Consider what changes under your ownership. Will you work the same hours the current owner does? Will you need to hire someone to replace functions they handle personally? The SDE calculation assumes you’re stepping into the owner’s role. If you’re not, your actual profit will be lower.
Business purchase analysis from a professional can catch things you’d miss on your own. Christian at Villa Group has helped clients across Los Angeles County evaluate acquisitions, and he regularly finds discrepancies between what sellers present and what the underlying documents actually show. Working with Los Angeles QuickBooks bookkeepers who understand due diligence can save you from buying a business that looks profitable on paper but isn’t.
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