Are Small Businesses Valued on Earnings or Revenues?

The value of most small businesses is ultimately based on earnings, not revenues.

In laymen’s terms, the values of most small businesses are directly related to the amount of money one full-time equivalent owner puts in his or her pocket annually from that business, i.e., “owner’s benefit” AKA Seller’s Discretionary Earnings ("SDE").

I’ll explain this using an example, which will help you understand why. Let’s suppose there are two identical businesses across the street from each other. One is in the mall, while the other is in a free standing building across from the mall. Let’s assume that both gross $500k annually, but the mall business pays $10k/month in rent, while the other only pays $3k/month. BINGO! Did the lights just come on?! That’s right, the business across the mall figured out how to generate the same revenue with less overhead; therefore, it’s worth more only if we compare the earnings of both companies, not revenues.