4 Reasons Why 68% of Amazon Businesses Are Undervalued

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What if I told you that there’s a 68% chance I can show you how to significantly increase the value of your Amazon business virtually overnight?

Well, better read up!

I’ve been brokering online businesses and websites for over 10 years now and this has given me the unique opportunity to look under the hoods of hundreds upon hundreds of businesses, including a lot of Amazon businesses.

When it comes to ecommerce businesses, there’s one specific issue that I keep running into all the time. So I ran the numbers and shockingly – the issue was present for a whopping 68% of the Amazon businesses I’ve looked at over the last 3 years.

And in many cases, it seemingly reduced the value of the business by over 20%! That’s no chump change.

Enough beating around the bush. Let’s cut to the chase.

Cash-Based Accounting – The Easiest Way to Undervalue an Amazon Business

Those of you who have been in the game for some time know that there are two main ways you can draw up your business’s financial statements – cash based and accrual.

I won’t go into the finer details, but to give you an overall idea:

Cash based accounting is when your Cost of Goods are recorded on your Profit & Loss Statement under the month & year in which you buy the goods.
Accrual accounting is when your Cost of Goods are recorded on your Profit & Loss statement under the month & year in which you sell the goods.

It’s a subtle difference, but an oh-so-important one.

Let’s assume you bought $100 worth of widgets in December of last year, sold $50 worth of them for $200 in income (25% gross margin), and are left with the other $50 still in stock.

Using cash accounting, your profit for the period is $200 (sales) – $100 (cost) = $100.

But with accrual accounting, your profit for the very same period is $200 (sales) – $50 (cost) = $150.

Huge difference!

Ok, let’s backtrack a little .. why is this stuff even important???

Cash v Accrual Accouting – How Much it Influences Business Valuations

It’s important because an ecommerce business is valued based on a number derived from its last 12 months’ net income. And net income can differ widely based on the accounting method used.

I’ve seen businesses with P&Ls showing profit of $200k, only for it to increase to over $300k when converted to accrual.

And guess what – when it comes to valuing and selling your business – this translates into real money!

A business doing $200k is going to be worth around $600k, while one doing $300k is worth $900k. That’s three hundred thousand dollars for an accounting technicality!

Consider the following example:

Here you can see a fictional cash-basis P&L of a simple ecommerce business that made three big stock purchases that year – in January, in June and in November.

As you can see, they’re reporting a net profit of $30,000.

But this means that by the end of the year, they were left with quite a lot of stock.

If we flick their accounts over to accrual, this is what it would look like instead:

A whopping 60% increase in profit, all the way to $48,000

And keep in mind that the two sets of accounts you’re looking at are of the same business! All that’s changed is the methodology, nothing else.

Not Just Lump Stock Purchases

“Ah, but that doesn’t really apply to me as I buy stock twice a month, not a few times a year“, you might say.

But it’s not just businesses that tend to buy stock in large junks that benefit from accrual accounting.

In fact, it’s nearly every single business that’s growing, and in this day and age, this means most online businesses.

That’s because a growing business will nearly always have more inventory today than it did a year ago, creating a gap between inventory levels.

In short: The only businesses that don’t benefit from switching to accrual accounting are those that have 100% constant inventory levels. That’s unless your business is on a decline, but that’s a different story.

And if that’s not enough – as you can see from the above examples, cash accounting also makes your financials look much more unstable (even if that’s not the case in reality), which will put off many potential buyers.

Ok, I’m Sold. Where Do I Sign?

Luckily, switching from cash to accrual isn’t very difficult in most cases.

As long as you’ve tracked your inventory properly, your accountant should be able to make the “flip” with only a little bit of work.

You can also do it yourself, or have your broker do it when selling or valuing your business, but the exact instructions for that would get a little technical so we’ll have to leave that for another write-up.

Your best bet, though, is to hit up your accountant and:

Ask them if your financials are currently prepared on cash or accrual basis;
If it’s cash, have them produce a set of accrual financials before you have a broker value your business or list it for sale.

Oh, I almost forgot.

Should you speak to a business broker and show them your cash-basis financials, but they don’t advise you to flip them over to accrual, do both yourself and the world a favor and fire the broker on the spot!

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Bryan O'Neil

Bryan is a serial entrepreneur with a passion for cutting-edge technology, business intelligence and the world of website acquisitions.

He's co-founded several influential firms in the online M&A space and continues to play an active role in the industry as a broker, consultant and thought leader.