TTM vs PY SDE

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June 12, 2023

by a searcher from Louisiana Tech University - College of Business in Houston, TX, USA

Broker wants to value business using higher TTM SDE, I think It should be the lower PY SDE. Which is the accepted approach for valuing the business. Also should i be looking at the schedule C numbers (cash basis) in my calculation or just on the income statement (accrual basis). Schedule C is showing far less earnings than P&L btw.

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Reply by an investor
from New York University in New York, NY, USA
It’s important to identify why TTM performance is higher than PY. If the growth in TTM is not driven by anything non-recurring, and just is in line with the trend of the past few years, I’m not sure what the argument would be to use PY. TTM is generally a more accurate reflection of the current state of the business. It also depends which TTM period you are looking at - if it’s TTM as of Oct 31, then PY is 10 months old and pretty stale. Standard practice for looking at M&A comps at all investment banks I’ve worked at in my past life was to focus on TTM results.

In terms of cash vs. accrual, the other posts covered the importance of the tax schedules in terms of financing. For a valuation driven by IRRs, naturally the focus is on cash flows - I’d start with accrual and then adjust to cash basis. For valuation driven by a multiple, I’d focus on accrual basis unless there is a big working capital / collections issue, and if some / all working capital is not included in the sale, I’d adjust the valuation for that since you will need to fund it and the accrual valuation assumes working capital is part of the enterprise. Hope this helps.
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Reply by a searcher
from Harvard University in Colorado Springs, CO, USA
Businesses are worth what someone is willing to pay for it, so your opinion is the only thing that matters with respect to what you'll offer (but also the bank's and your investors').
The bank is likely to base its underwriting on the average of the schedule C for the last 3 years, so that's definitely a good argument to lean on with the broker.

However, banks also know that "some" of the expenses that a business owner writes off as taxable are more discretionary, which leads to the second point. It's basically a rule that the business produces more "discretionary earnings" (which isn't a real financial term IMHO) than the Schedule C shows, so that's not a red flag in and of itself. This is why brokers/owners add back some of the tax-deductible expenses. I typically reverse some of the add backs that the owner/broker propose, but I find that most are reasonable.

Best of luck!
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