By Patrick McAdams, CM&AP, BCI | Murphy Business Sales – Waukesha | Published January 5, 2021 | Updated October 2026
The short answer: A business is sellable when the cash flow on the books, called Seller’s Discretionary Earnings (SDE), is large enough to pay a new owner a reasonable salary, cover the loan payment, and still leave profit in the business. Cash that never made it onto the books cannot be counted, because no buyer or bank can verify it.
I talk with business owners every week about selling. When I ask whether their business is sellable, many look at me like I’ve asked whether water is wet. Of course someone will want it. They have a nice home, a boat, a convertible, and a country club membership. The business is clearly a money maker.
My job is to temper that enthusiasm and ask the right questions, because a comfortable lifestyle and a sellable business are not the same thing.
Not enough cash flow. More specifically, not enough SDE to support a sale.
SDE is the profit the business generates, plus the owner’s salary, interest, depreciation, amortization, and any perks run through the business. That total has to be large enough to do three things:
Some small businesses sell for mostly cash, but many need financing. That might be a loan against the buyer’s home, money from a relative, or an SBA loan. In my deals, most sales use SBA financing, often with a seller-financing portion. Whoever is lending will want to see numbers they can verify.
I hear it often: “There’s more money in the business than my books show.”
As a broker, that’s a red flag. There is no way to prove the business makes the cash the owner claims. I can’t value or sell a business based on unreported income, and neither a buyer nor a bank can count it. If the cash flow isn’t documented, it doesn’t exist as far as a sale is concerned.
Underreporting income is also illegal, which is one more reason to keep the books clean.
Here are two identical fictional businesses with the same revenue. Business X reports all of its revenue and pays its owner a fair salary. Business Z reports only part of its revenue, takes the rest in cash, and pays some employees in cash. Owner Z does this to pay less in taxes. Below are their recast financials, where we add back the owner’s salary, depreciation, interest, and perks. Owner X has a few more add-backs than Owner Z.
| Business X | Business Z | |
|---|---|---|
| Business Net Income | $43,600 | $600 |
| Plus: Owner’s Salary | $70,000 | $37,800 |
| Plus: Depreciation/Amortization | $10,500 | $10,500 |
| Plus: Interest | $4,500 | $4,500 |
| Plus: Owner’s Perks | $10,000 | $5,000 |
| Seller’s Discretionary Earnings | $138,600 | $58,400 |
| Supportable Purchase Price | $360,500 | $106,800 |
For this example, let’s assume Owner Z keeps about $81,000 a year in unreported cash. On the books, though, Business X is worth about 3.4 times as much as Business Z, a difference of $253,700. Business Z’s SDE of $58,400 is less than the $60,000 salary a new owner would need, before a single loan payment. If Owner Z can convince a buyer that the unreported cash exists, the buyer will probably have to pay all cash, or the seller will have to finance part of the sale to prove what the business really earns.
Let’s assume both owners pay a combined federal and state rate of 15% on their personal and business income. The real brackets would differ, but this keeps the math simple.
| Business X | Business Z | |
|---|---|---|
| Reported income (owner salary + business net income) | $113,600 | $38,400 |
| Taxes per year at 15% | $17,040 | $5,760 |
| Taxes over 3 years | $51,120 | $17,280 |
| Tax savings over 3 years | – | $33,840 |
Owner Z saved $11,280 a year, or $33,840 over three years. In exchange, Business Z gave up more than $250,000 in value, and there’s a good chance it can’t be sold at all. Owner X paid more in taxes and can expect a much better payday at closing.
Before a buyer commits, I run a Purchase Price Justification Test, also called a Buyer’s Sanity Test. It checks whether the business can pay the new owner a fair salary, make the loan payment, set aside money for capital expenses, and still repay the buyer’s down payment over time.
Both scenarios use the same assumptions: a 15% down payment, a 10-year SBA loan at 7.75% interest, a new owner salary of $60,000, $5,000 a year in capital expenditures, and a 5.0% required rate of return on the down payment. Rates change, so a buyer should confirm current terms with their lender.
| Purchase Price Justification Test | Business X | Business Z |
|---|---|---|
| Purchase Price | $360,500 | $106,800 |
| Down Payment | $54,075 | $16,020 |
| Loan Amount | $306,425 | $90,780 |
| Interest Rate | 7.75% | 7.75% |
| Term (years) | 10 | 10 |
| Annual Payment | $45,153 | $13,377 |
| Business Net Income | $43,600 | $600 |
| Plus: Owner’s Salary | $70,000 | $37,800 |
| Plus: Depreciation/Amortization | $10,500 | $10,500 |
| Plus: Interest | $4,500 | $4,500 |
| Plus: Owner’s Perks | $10,000 | $5,000 |
| Seller’s Discretionary Earnings | $138,600 | $58,400 |
| Less: New Owner’s Salary | $60,000 | $60,000 |
| Less: Capital Expenditures | $5,000 | $5,000 |
| Less: Required Rate of Return (5.0% on down payment) | $2,704 | $801 |
| Less: Debt Service | $45,153 | $13,377 |
| Excess Cash | $25,743 | ($20,778) |
| Go or No Go | Go | No Go |
Business X has cash to spare after paying the new owner, making the loan payment, covering capital expenses, and repaying the buyer’s down payment. Even at 7.75%, with a loan payment about $3,500 a year higher than it would be at 6%, it still passes. Business Z comes up $20,778 short even at a purchase price of $106,800, so a bank has no documented cash flow to lend against.
That is the point for owners worried about interest rates. A business with strong, documented cash flow can absorb higher borrowing costs. A business with weak or unreported cash flow cannot, at any rate.
Keep the cash in the business. The short-term cost of paying taxes is worth it when it lets you sell for a much higher price.
My former CPA used to say that paying taxes is a sign of a healthy business, one that can be sold someday. After years of watching deals come together and fall apart, I agree.
What does it mean to say a business is sellable?
Its documented cash flow can cover a fair salary for the new owner, the loan payment, and some profit left in the business.
What is SDE?
Seller’s Discretionary Earnings is the business’s profit plus the owner’s salary, interest, depreciation, amortization, and perks run through the business. It shows the total cash flow available to a single working owner.
Can I count cash I take out of the business that isn’t reported?
No. Buyers, lenders, and brokers can only rely on documented income. Unreported cash cannot be verified, so it adds nothing to the value of the business.
Why does reporting more income raise my business value?
Value is based on verifiable cash flow. Higher reported earnings support a higher price and make it possible for a buyer to get a bank or SBA loan.
Do higher interest rates change whether a business can be financed?
They raise the loan payment, which leaves less excess cash. Businesses with strong documented cash flow can usually still pass the test. Businesses with thin or unreported cash flow have no cushion.
How long before a sale should I clean up my financials?
Ideally years. Buyers and lenders typically look at the last three years of tax returns, so the earlier your books reflect the business accurately, the better. See my post on https://murphybusiness.com/waukesha/article/how-long-to-sell-a-business-in-wisconsin-plan-5-years/
I help business owners across Wisconsin, including Waukesha County, find out where they stand and plan a sale. If you’re not sure whether your numbers will support a sale, I’m happy to start a confidential conversation. We can review your financials together and build a plan from there.
Contact Patrick McAdams | Murphy Business Sales – Waukesha
The businesses and figures in this post are fictional examples for illustration. They are not tax or legal advice. Talk with your CPA about your own situation.