Normalization of online business results
When you want to sell an online business and set a price that properly reflects the value of this web store, in most cases your starting point is the net result of the web store. In a number of cases it is possible and sometimes even necessary to make corrections to these results before using them as the basis for a valuation.
What is normalizing
Normalization is the correction of the effect on net income of costs and revenues that have not been part of the actual operations.
When are results normalized?
Companies sometimes take investments as expenses, while they could have capitalized them and depreciated them over several years. This may seem like a way to reduce profits (read: taxes) in the financial year in question, but it gives a distorted picture of the net profit for that year.
By spreading this investment over several years, the net margin of that year improves and is thus the basis for a valuation.
What we also often encounter are irrelevant costs: think of the mobile subscription of a family member, which is on the company account. Or a car that is not actually needed to run the business.
A similar reasoning applies to non-recurring expenses (think of a lawsuit). These costs have reduced the result once but will not return next year. One could normalize for this and this has a positive effect.
But the other way around (and unfortunately, we come across this more often) it happens quite often that entrepreneurs have not recorded costs for their own time. Also, in this case the results will have to be normalized. In this case normalizing has a negative effect for the value.
The entrepreneur’s hours
Especially entrepreneurs with a sole proprietorship or a general partnership often take the net profit stated in their financial statements as the basis for a valuation. However, this is not the correct basis for determining web store value. The confusing thing is that in the case of a sole proprietorship/General Partnership, the net profit is literally stated as such in the annual report, but this is directly the entrepreneur’s salary. However, when valuing, all costs should be considered. And the time an entrepreneur puts into his business are necessary costs: after all, what would be left of the results if he did not put in the time?
A buyer will also look at it this way: the ‘money machine’ that is to be taken over will no longer produce any results if he does not put in any hours of his own or his staff’s time.
Many buyers therefore have the habit of first checking whether the seller has taken his own time into account as a cost component.
It is wise to be ahead of this and calculate for yourself what time you put into what activities. It makes sense to give yourself a lower hourly rate for the simple (packing) work and a higher rate for the online marketing work.
Normalization serves mainly to get as realistic a picture as possible of (the operational part of) the company. What are the necessary costs to at least maintain the projected results?
This is essential input for a valuation of those results and the outcome is therefore partly determined (negatively or positively) by the normalizations applied.
More information about valuation methods.