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Why Accrual Accounting Maximizes The Value Of Your Ecommerce Business
By Quiet Light
The accrual accounting method can add significant value to your ecommerce business.
It might seem odd that organizing your books differently can make such an impact on the value of a business, but it truly does make a significant difference.
In this article, we explain how accrual accounting:
- Gives you greater visibility in your business
- Can reduce your expenses
- Increases revenues
- Reassures your buyers
Together, these elements contribute to making your business more valuable in the acquisition marketplace.
A Quick Overview: What Is The Accrual Method?
There are numerous accounting methods but two of them are most common: cash and accrual.
“The difference between cash and accrual-based accounting is quite simple. In cash-basis accounting, revenues and expenses are recorded as they are received or spent. In accrual-basis accounting, revenues and expenses are recorded as they are incurred. The differences between the two types of accounting show up most clearly for firms carrying inventory, and for companies that pay or receive their payments on terms.”
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Cash accounting creates problems for businesses with inventory (i.e ecommerce businesses).
Cash accounting can record an expense that shouldn’t be counted yet. If you buy inventory, you have simply traded one asset (cash) for another one (inventory). This is not an expense and recording it as such can skew your books.
With accrual-basis, Cost of Goods Sold (COGS) is roughly the same percentage of the total income each month. But with cash accounting, the COGS goes up and down each month with significant peaks and troughs when values suddenly change.
The two methods would eventually match up to show a similar picture, but when it comes to a quick snapshot in time, cash can be deceptive.
It will be difficult for a buyer to get a true gauge on how your business is performing using the cash method because of these sudden changes.
For this reason, accrual accounting is best practice for ecommerce businesses.
And not just when it comes time to sell one either. You should be using accrual accounting as early as possible. It’s also required as part of the GAAP (Generally Accepted Accounting Principles) for businesses of a certain size.
With that overview, lets explore more deeply how accrual accounting can maximize the value of your Ecommerce business for sale.
4 Benefits of Accrual Accounting (And How It Can Help Maximize Business Value)
Your buyers decide how much your business is worth.
You will provide an estimate based on what’s considered “attractive” to buyers, but it’s ultimately down to whether they make an offer or pass.
So it’s their criteria that we need to focus on when figuring out how to maximize value.
When buyers are looking at potential business investments, they’re weighing up a number of things. Two key areas are growth potential and risk factors.
Within these pillars, they’ll be looking at a few different elements.
- Size and age of the business
- Its defensibility in the market
- Its dependencies
- The sales channel(s)
- Potential obsolescence
- Top- and bottom-line trends
- Paths to growth
It’s useful to understand the headspace of potential buyers when framing why a particular accounting method will increase the value of a business.
All of the accrual accounting benefits below help a seller to balance their growth and risk factors, offering potential buyers a transparent, resilient, and defensible business.
Those types of businesses are the ones that sell for the best prices.
1. Accurate Forecasting
Accrual accounting tells you when orders took place regardless of when the inventory was purchased.
“This means that your Cost of Goods Sold (COGS) is roughly the same percentage of your total income each month, month over month. With cash accounting, the COGS percentage goes up and down each month and then way up again in the quarter that you bought a container load of something for the business.”
In terms of forecasting, this is useful because it helps you:
- Get a feel for seasonality and trends
- Accurately plan for peaks and troughs in demand
- Keep storage costs minimal by only using the space for stock that will sell
Without an accurate feel for future order volumes, you could sell stock you don’t have, be out of stock for significant periods, or pay too much in storage fees for inventory that isn’t moving.
That’s not a well-functioning business. And it won’t attract top-paying buyers.
How more accurate forecasting maximizes the value of your business
As a business owner, you don’t want too much or too little stock on hand. You want to hit just the right amount, but that’s only possible with some rigorous inventory management. Accurate forecasting sits at the heart of that.
By nailing your forecasting, you’re increasing your defensibility in the market, minimizing the dependencies of your business, and managing your top- and bottom-line trends.
2. Better Budgeting
Business owners want to make money and buyers will be no different. But knowing what’s safe to take out of a business so it can still grow requires accurate accounting.
Accrual accounting gives you better visibility over your true cash flow and the movement of value in your business. Armed with this information, you can make informed decisions about when and how much to invest or withdraw.
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You’re safe in the knowledge that upcoming bills or orders are accounted for, and you can allocate funds with confidence. That’s funds to maintain and grow your business, and a salary for you as well.
How better budgeting maximizes the value of your business
Accrual accounting makes it easier to demonstrate to a buyer how much money it takes to keep the business running and on a growth trajectory.
It’s easier to see what costs are coming up, plan for them accordingly, and still be able to take a salary or cut of the profits.
3. More Strategic Reporting
Your profit and loss statement (P&L) and balance sheet will always be accurate with accrual accounting (all else being equal).
By recording assets and liabilities correctly, you can trust that these snapshots are up-to-date and reliable.
These aren’t just useful references but can be used strategically in your business. Diagnose problems, find single points of weakness, and spot opportunities in your accounts for a resilient business and smart planning.
How strategic reporting maximizes the value of your business
Your accounts should play a central role in your business operations. Rather than just an administrative box to check, they should form the basis of your decisions and strategy.
But this can only happen if they’re reliable, accessible, and always up-to-date.
Passing organized accounts to a new buyer enables them to make a smooth transition to running the business without losing money in the interim. They can take over with confidence knowing the business’s history, current state, and likely future numbers.
Buyers are much more likely to pay higher prices for a business like this.
4. A Better SDE Multiple
Cash accounting often depresses your Seller’s Discretionary Earnings (SDE) multiple. And it’s this multiple that forms the foundation of your business’s valuation.
You want the multiple to reflect what’s actually happening in your business so that you get the amount you deserve.
It can make a huge difference to get the numbers right. In fact, QuietLight was able to increase the value of one business by $250,000 simply through accurate accrual accounting.
How a higher SDE multiple maximizes the value of your ecommerce business
Your SDE multiple forms the base for your business valuation. A lower multiple could result in thousands less for your business – all caused by your accounting method!
There’s a lot to accrual accounting but as you can see, it’s worth the time and effort.
Plus, by connecting A2X with your ecommerce store, your accounts are organized this way for you on autopilot.
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