A profitable business can still leave you broke.
That might sound counterintuitive, especially if you’re considering purchasing an established business with a history of profitability. However, one of the biggest mistakes prospective business buyers can make is assuming that the seller’s historical earnings will become their personal income.
The first business I ever bought was a retail business that I owned and operated for nearly ten years. One of the most valuable lessons I learned during that time was that making a profit and having money available to take home are two very different things.
Today, as a business broker and entrepreneur, I encourage prospective buyers to understand this distinction before committing to an acquisition.
Buying a business can be an excellent path to entrepreneurship and wealth creation. But understanding the financial realities of ownership is essential to making an informed investment decision.
When evaluating a business for sale, buyers will often encounter a financial metric called Seller’s Discretionary Earnings, or SDE.
SDE is commonly used to evaluate the earnings of owner-operated businesses. It generally reflects the business’s earnings before interest, taxes, depreciation, amortization, one owner’s compensation, and certain discretionary or nonrecurring expenses.
It provides a useful starting point for understanding the financial benefits available to an owner-operator.
However, SDE is not necessarily the amount of money a new owner will be able to take home.
Why? Because the buyer’s financial circumstances, financing structure, operating expenses, and capital requirements may be considerably different from those of the seller.
The seller may own the business outright. You may need to borrow money to acquire it.
The seller may perform certain responsibilities personally. You may need to hire someone to perform those same duties.
The seller may have accumulated sufficient cash reserves over many years. You will need to determine how much working capital is required from your first day of ownership.
These differences can significantly change the financial outcome of an acquisition.
Imagine you’re considering purchasing a business that generates $200,000 in annual Seller’s Discretionary Earnings.
At first glance, that might look like a business capable of providing you with a $200,000 annual income.
But consider the following hypothetical financial breakdown under your ownership:
| Financial consideration | Annual amount |
|---|---|
| Seller’s Discretionary Earnings | $200,000 |
| Acquisition loan payments | ($85,000) |
| Equipment replacement and capital expenditures | ($15,000) |
| Additional working capital requirements | ($20,000) |
| Remaining cash before income taxes | $80,000 |
In this simplified example, the buyer has approximately $80,000 remaining before income taxes, assuming the historical earnings continue and no other adjustments are necessary.
That’s a very different financial outcome from the $200,000 the buyer might initially have expected.
And if revenue declines, expenses increase, or unexpected repairs become necessary, the amount available could be even lower.
The numbers above are illustrative, not a prediction of any particular acquisition. Actual results will depend on the business, financing terms, operating performance, and the buyer’s circumstances.
The important takeaway is this:
Revenue isn’t profit. Profit isn’t cash flow. And cash flow isn’t necessarily money you can take home.
Many business acquisitions involve financing, whether through a commercial lender, an SBA-backed loan, seller financing, or a combination of funding sources.
Your acquisition financing creates an additional financial obligation that must be supported by the business.
Remember that debt principal payments generally do not appear as expenses on a profit and loss statement, even though they require actual cash.
Before making an offer, understand your anticipated monthly loan payments, interest rate, repayment period, and the effect those obligations will have on available cash.
A business may generate attractive earnings, but the acquisition structure must leave sufficient financial flexibility to operate successfully.
Working capital is one of the most important—and sometimes underestimated—considerations when buying a business.
Depending on the industry, you may need cash to purchase inventory, pay employees, cover rent, fund marketing, and pay suppliers before receiving payment from customers.
A business can be profitable while experiencing cash flow pressure because money is tied up in inventory or accounts receivable.
For example, a commercial service business may need to pay employees and purchase materials several weeks before its customers pay their invoices.
Understanding how much cash is required to support this operating cycle is essential.
Make sure you understand what working capital, inventory, receivables, and other assets are included in the transaction and what additional funds you will need after closing.
Historical earnings do not always tell you when equipment will need to be replaced.
A business may have operated profitably for years while relying on aging vehicles, machinery, computers, or other equipment.
If significant replacement expenses are approaching, those costs could become your responsibility shortly after acquiring the business.
Review the condition, age, maintenance history, and anticipated replacement costs of major assets.
An appropriate capital expenditure reserve can help protect the business from unexpected financial strain.
Annual financial statements can conceal significant monthly fluctuations.
A business might generate most of its annual profit during a few months of the year while struggling to cover operating expenses during slower periods.
This is particularly important in industries such as retail, landscaping, hospitality, tourism, and other seasonal businesses.
The timing of your acquisition can also matter. Purchasing a business immediately before its slow season may require substantially more cash reserves than purchasing it before its busiest months.
Don’t simply ask whether the business makes enough money over the course of a year.
Ask whether it will have enough cash to meet its obligations every month.
Every buyer has different financial needs and goals.
Someone purchasing a business to replace a corporate salary may require a different level of income than someone who has additional household income or substantial personal savings.
Determine how much money you need from the business to support your personal financial obligations.
Then evaluate whether the business can reasonably provide that income after servicing acquisition debt, funding operations, and maintaining appropriate reserves.
The objective isn’t simply to buy a profitable business.
It’s to buy a business that makes financial sense for you.
One of the most valuable exercises you can complete before purchasing a business is building a monthly cash flow forecast for your first year of ownership.
Start with the business’s historical monthly financial performance and adjust it to reflect your anticipated operating conditions.
Your forecast should include:
Review the projected cash balance for each month, paying particular attention to periods when cash reserves may become limited.
You should also consider a downside scenario. What happens if revenue is lower than expected? What if expenses increase or a major piece of equipment needs to be replaced?
Understanding these possibilities before closing can help you determine how much capital you need, whether your proposed financing structure is appropriate, and whether the acquisition fits your financial objectives.
Your accountant, lender, and other professional advisors can help you evaluate these assumptions during the acquisition process.
Buying an established business can provide tremendous opportunities for income, independence, and long-term wealth creation.
But the decision should be based on more than historical profitability or an attractive purchase price.
A successful acquisition requires understanding what the business earns, what it needs to operate, and what it can realistically provide under your ownership.
Because ultimately:
You’re not buying the previous owner’s financial experience. You’re buying your own.
At Murphy Business Sales, our team helps prospective buyers identify business opportunities, evaluate acquisitions, understand the transaction process, and navigate the steps toward business ownership.
Whether you’re purchasing your first business or expanding an existing portfolio, we can help you approach the process with a clearer understanding of the opportunities and financial considerations involved.
Contact our team to discuss your acquisition goals.
Murphy Business Sales
Phone: (916) 905-4997
Visit our website to learn more about our business acquisition services or request a consultation.
About the Author
Terry Watts, MBA, CM&AP, CEPA, is a business broker, entrepreneur, and franchise owner with Murphy Business Sales. His experience includes buying, operating, growing, and selling businesses across multiple industries. He brings practical business ownership experience to helping entrepreneurs evaluate acquisitions and business owners navigate the sale process.
California DRE License #02191771
Murphy Business Sales franchises are independently owned and operated.
This article is for general educational purposes and does not constitute individualized financial, legal, tax, or investment advice.