Amazon FBA businesses tend to be valued according to a multiple of gross earnings before tax, plus the cost of stock in Amazon warehouses (including the cost of getting stock into Amazon's warehouses). For the purpose of valuations, the only expenses that are taken into account are the cost of goods sold, and necessary expenses required to run the business. A common industry term that refers to this earnings calculation is "Seller Discretionary Earnings" (SDE). Generally, valuation multiples are calculated based on annual SDE. However, for businesses that are in a rapid growth phase, or have been declining for the past 3-6 months, it can be useful to use a multiple of monthly SDE. Annual SDE takes more data into account, and provides a more reliable picture of the how the business is performing and growth trends moving into the future. Therefore, older businesses that use annual SDE tend to command a higher valuation multiple than newer businesses that are valued using monthly SDE.
When preparing accounts for tax and bookkeeping purposes, it is in your best interests to record any justifiable expense that reduces profit, as this results in less tax being paid. However, for the purpose of providing a valuation, the opposite of this rule applies. Buyers of FBA businesses have all different circumstances, and depending on their personal situation, they may or may not need to incur all expenses that you do. Costs such as owner's salary, rent on offices, employees (where they are not absolutely necessary), insurances and vehicles should not be included in the SDE calculation.
When valuing your FBA business, you can use information from existing financial statements, and account for the expenses that are not absolutely necessary to continue running the business by using addbacks. An addback represents an expense that is not integral to your business operations.
From a high-level perspective, Seller Discretionary Earnings can be calculated as follows:
In theory, this calculation can be shortened to:
To determine if you can record an expense as an addback, ask yourself "is this expense absolutely necessary to continue running the business?" Below are some examples of expenses that may be recorded as addbacks (depending on your specific situation):
For a more detailed discussion on this topic, and an example of what addbacks look like in the profit and loss statement, refer to the first section "Step One: Why You Need Clean Financials" by Quiet Light Brokerage - Link here
The value of your Amazon business can therefore be calculated as follows:
(Seller Discretionary Earnings X Valuation Multiple)
Inventory at cost
Cost of getting stock into Amazon warehouses
Cash accounting is a method where income and expenses are recorded when money changes hands: income is recorded when money is received, and expenses are recorded when bills are paid. Accrual accounting, on the other hand, records transactions when they occur: income is recorded when sales are made (or other income-generating activity occurs), and expenses are recorded when orders are placed or other expenses are incurred. Accrual accounting tends to provide a more accurate picture of the financial position of a business. We live in a credit-based world,
where debts are often settled long after the fact. When valuing a business using the cash accounting method, sales income that has not yet been received is excluded from the income statement and profit figures (along with expenses that have not yet been paid). Oftentimes, the suppliers of Amazon businesses require payment upfront for goods supplied whilst Amazon pays FBA sellers every 14 days. Compared to the accrual accounting method, cash accounting tends to under-represent profit levels in an FBA business, thus reducing the valuation offered to potential buyers.
It is important that your financials represent an accurate picture of where the business is at. However, working only with Amazon's reporting in Seller Central is "extremely difficult and time consuming to reconcile accounts month to month whilst also including detail around fees, currency exchange costs, and other expenses" (Do your financials tell a story that sells). Dedicated accounting software for FBA businesses such as A2X makes this task a breeze. This is done by importing the correct data from Amazon, allocating income and expenses to the correct period, and automating the process of record keeping. By removing the potential for human error, potential buyers can be confident that accounts are more accurate and representative of the true state of the business.
Generally speaking, FBA businesses tend to be valued at around 2-3 times SDE. The valuation multiple can vary. Businesses without a unique offering, or sold with an immediate urgency for cash may fetch valuations closer to 0.5-1.5 times SDE, whereas businesses with a strong brand and unique, highly demanded proprietary products (or businesses that are ready to release new products with all research completed and/or enter new markets) may fetch valuation multiples above 3 times SDE.
So what factors have an effect on the valuation multiple? When valuing a business, there are many variables that can be taken into account. The following graphic provides more insight into the main valuation drivers:
At the end of the day, a business is only worth what a buyer is willing and able to pay for it. The more interested parties that are willing and able to buy the business, naturally, the more it is going to be worth.
Below, we will discuss each of the valuation drivers in a little more detail:
Type of FBA business? Businesses with strong brands and/or proprietary products are going to command a higher valuation multiple than private label businesses; private label businesses are going to command a higher valuation multiple than resellers. This is because more value is added, and the respective businesses market position and market share is more defensible as you move from one category of FBA business to the next.