This is the fourth post in a series called “Valuing Your E-Commerce Business”. Click here to see all posts in this series.
Over the past few posts, we’ve broken down what to expect during the process of selling your e-commerce business, from how to navigate add-backs to what kind of deal structures you may encounter from a buyer. In this final installment of the Valuing Your E-Commerce Business series, Seller Accountant CEO Tyler Jefcoat breaks down some of the tidbits he’s learned from helping sellers prepare for 6x+ deals.
Though it seems obvious, it’s worth repeating: the more profitable your business is, the more it’s ultimately worth. But what’s less obvious is the implications that profitability has for a potential buyer.
If a business is extremely profitable, it generally has great margins and great post-advertising gross profit (PAG), which increases the buyer’s margin for error exponentially. If your business runs like a well-oiled machine, it’s less risky for a buyer to make changes to one area (the whole brand won’t fall apart if he decides to spend more on ads or try out a new supplier).
That being said, it becomes crucial as the seller to understand your cost of goods sold, your ad spend, and most importantly, your PAG, and how each affects your overall margins.
Once you’ve taken a look at the product side of things, reducing your overhead is another important step in keeping costs down and ultimately increasing your profitability. As mentioned in part one of this series, keeping your business “lean and mean” when it comes to spending will end up winning you a lot of battles you won’t have to have in the negotiation room.
Just like consumers, buyers want to see that you’ve put thought into your brand strategy. A brand that sells a mixture of toys, skincare, and dog shampoo may make you money, but it looks disorganized and low-value to a potential buyer.
Your portfolio of products should be cohesive and coherent, allowing the buyer to see the “story” of your brand. This way, your business shows potential to expand off of Amazon, potentially into a brick and mortar store, or even just as a standalone web store. Concentrating on brand cohesion indicates to buyers that you’ve thought about how to market to ideal customers, which in turn makes their future job selling your products easier.
Aside from the obvious attention given to running your business in a profitable way, having investor-grade accounting is crucial to ultimately making a good sale.
A good profit and loss statement (P&L), like the one shown above, is EXTREMELY readable even to the least experienced buyer. Your P&L should articulate your business’s performance by sales channel (Amazon, Shopify, eBay, etc.), as well as be parsed out by month so it’s easy to tell exactly which numbers belong to which period.
This is where accrual accounting comes in: accrual accounting allows your landed sales numbers to hit your report in the correct months, which creates both a simplified view of your COGS and more consistent gross profit data to track over time. If you’re still using cash-basis accounting, your books will likely be too complicated to go through necessary due diligence.
A solid P&L also has the advertising information in one easy-to-read place. Ad costs tell buyers what kind of investment they’ll need to put in in order to make sales, so making this data easily available makes your buyer’s job easier and negotiations less of a communication struggle. Much like buying a car at a used car lot or trying to sell a house, the “curb appeal” of your clean P&L leaves a good impression on your buyer.
Return on Working Capital
Finally, possibly the most overlooked metric you should focus on as a seller is Return on Working Capital.
ROWC is the understanding of how inventory velocity affects profitability, and many sellers completely ignore this data when considering their margins. This metric considers both how much cash is required to make a profit AND how often that cash infusion happens over the course of the year. In other words, how much do you make for every dollar you put into your products, and how often do you have the chance to put another dollar in?
A simplified way to calculate your ROWC by taking an objective profit metric (like PAG) over 12 months and dividing it by your average inventory balance for the year (how much of your money is tied up in inventory). The result is how many times you can turn your product over in the course of a year, and anything over 2.5 is considered a healthy inventory velocity.
If your ROWC is lower than you’d like, your objective should be to figure out where you can improve your inventory turnover, such as renegotiating your supplier terms or getting rid of old SKUs that aren’t selling. Improving your ROWC will allow you to present a clean turnover rate to potential buyers.
If you need help with your bookkeeping because you see how investor-grade financials will get you closer to your dream exit, or if you need financial coaching on how to strategically steer your company, we’d love to have a chat with you! Book a free 15-minute discovery call here.