Most valuations of an e-commerce business look at the historical earnings—the net profit of the business for at least the last twelve months—and apply a multiplier (typically between 1.5 and 3.5, though some calculations put the multiplier as high as 5) to arrive at the company’s valuation.
Let’s quickly look at this in action. Assume there is an e-commerce business that has made £100,000 net profit in the last 12 months and has been given a multiple of 2.75x based on many factors. With this information, we can calculate the value of the business, which would come out to be worth £275,000. This gives an example of how a multiple is used to reach the valuation for the business.
Some of the most important factors are revenue growth, consistency, scalability and the amount of work required to operate the business. Somewhat simplistically, the more favorable factors presented, the higher the multiplier and, hence, the higher the valuation.
Discounted Cash Flow Analysis, (DCF)
Essentially this is an estimate of future return on investment, adjusted for the time value of money (i.e., £100 received today is worth more than £100 a year from now because today’s £100 invested at, say, a 10 percent rate is worth £110 a year from now). Basically, DCF calculates the last year’s free cash flow (FCF) by subtracting capital expenditures from the period’s operating cash flow.
Due to the wide variance in monthly cash flow typical of e-commerce ventures and the volatile nature of e-commerce markets in general, DCF is not well-suited as the primary method to value an e-commerce business.
for example, show a significantly improved FCF in the current year over last year, prompting an investigation into its cause and likelihood of continuing.
While also not a primary valuation method, the acquisition price of similar companies in similar markets can provide some useful points of reference. It is therefore important to identify the metrics used for the transaction to come up with an accurate comparison. Even then, this is more of a “reality-check” than what ultimately determines an e-commerce company’s valuation.