You’ve put in all the hard work to start and grow your e-commerce company, so now what? Whether the goal is to sell or to continue growing, all business owners should know how to calculate and track their business valuation as part of a financial plan. This information is crucial to understanding the overall financial picture of both the company and the owner, and it can help make the business more profitable. Consistently tracking the valuation will help you feel confident in yourself and the business you worked so hard to build. Though it’s important, it doesn’t have to be overly complicated. Here are three easy steps to help you get started.
Business Valuation Step 1: Calculate Earnings
The first step in valuing your business is to calculate your annual earnings. There are two methods for this calculation:
- Seller’s Discretionary Earnings (SDE): Used to calculate the earnings of businesses with an estimated value of $10 million or less, SDE is determined by subtracting both the cost of goods sold and operating expenses from revenue. Owner compensation is then added back to the formula since it is an expense the buyer can choose to decrease or forgo altogether.
- Earnings Before Interest, Taxation, Depreciation, and Amortization (EBITDA): This method is used to calculate the earnings of businesses with an estimated value greater than $10 million. At this size, the business is assumed to have multiple levels of employees and managers that are essential to the overall operation of the business. Therefore, employee compensation is not added back to the revenue.
Business Valuation Step 2: Determine Earnings Multiple
Once the earnings have been calculated, the next step is to determine the earnings multiple. This is the most complicated part of valuing a business. The earnings multiple is typically between 2.5 and 5 for most e-commerce businesses and it is multiplied by the earnings calculated in step 1 to determine the total valuation of the business. The earnings multiple is based on a number of factors, many of which are industry-specific. The most important e-commerce valuation factors include:
- Finances: This is a hugely important aspect of any business and it greatly impacts the earnings multiple. Owners will need to produce verifiable financial records as well as show how the revenue is concentrated. This can be done by calculating financial benchmarks like the average order value, average revenue per customer, and monthly recurring revenue. The more diversified and consistent the revenue streams, the greater the earnings multiple.
- Traffic: Another critical factor when valuing an e-commerce business, this provides insight into the business’s target market and its potential for growth. Google Analytics is a great tool that can help track key data points, including monthly unique visitors, customer conversion rate, and bounce rate.
- Customer service: A robust customer service offering can greatly increase the valuation of your e-commerce business. Studies have shown that options such as live chats, a comprehensive FAQ, and detailed product descriptions can increase customer satisfaction and conversion rates up to 20%!
- Logistics and order fulfillment: This is another very important element, particularly when trying to compete with companies like Amazon. Automation and outsourcing are great ways to enhance this area of an e-commerce business, improving both scalability and valuation.
Business Valuation Step 3: Tracking Changes in Valuation
Now that you’ve calculated your business’s valuation, it’s time to interpret the results and keep track of the changes. This can and should be done in the context of your overall financial plan. The more analytics you have around your business, the better equipped you’ll be to adapt to changing market conditions and improve profitability. By periodically valuing your business, you can implement changes and track the effects over time to see which strategies are most effective.
How We Can Help
Business valuation should be a part of every owner’s financial plan. You’ve worked hard to build your eCommerce business and Tree Street Advisory is here to help you maximize its value. Call (615) 219-9802 or schedule a free 30-minute introductory appointment.