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What's the real profit?
Profit is a much misunderstood term in the website buying/selling industry. It's often miscalculated, used in the wrong sense or confused with other similar terms. Claimed "profit" can never be taken at face value, is not a figure written in stone and it's up to the buyer to independently arrive at the figures he believes best represent the company or website's profits.
The most serious sin in the business is the confusing of profit with turnover. It doesn't help that in some countries like the US, the term revenue is used to mean both profit and turnover! The next sin is the (sometimes) intentional and fraudulent presentation of gross profit as net profit. It's up to the buyer to never rely on seller provided summaries of core deciders such as Profit but to take the raw figures, verify they are true and calculate the deciders himself. And there's an art to doing that which we'll discuss later.
Turnover: The total amount a business has taken in sales. Costs like hosting etc will need to be deducted from this to arrive at any sort of profit figure. Not anywhere as useful a figure in deciding value as the Net Profit.
Gross Profit: Gross profit is the "net" sales (sales less returns) for the year less the cost of goods sold. For most websites there is no cost of goods sold if the entire turnover is from the sale of ad space or electronic items like ebooks. However, ecommerce businesses that ship physical goods usually have a cost to the stock.
(Total Sales for the Year) - (Sale Refunds) - (Cost of Goods Sold) = (Gross Profit)
Net Profit: When all other expenses are deducted from the Gross Profit we arrive at the net profit. Note that it's not only real expenses like hosting and advertising that need to be deducted but also nominal expenses like pay for any time the owner/manager has "donated" towards the running of the site. We'll discuss this in more detail soon.
Cash Flow: The excess (or shortfall) of cash receipts over cash expenditure over a certain period. Caveat: Cash flow is not the same as profit. A business could build up huge debts to keep expenses out of its cash flow statement and appear to be a lot healthier than it really is.
The safest option is to treat all claims of "revenue" as Turnover and get proof of the breakdowns that support the figure. You can never accept a seller's calculation of net profit as gospel. Trust only that which you can verify to your complete satisfaction.
In the purchase of businesses it's common for the buyer (or his advisers) to recalculate profit figures even if the seller's accounts are impeccable and fully audited. That's because two people calculating the profit of a business can legally - and within accepted accounting rules - arrive at two completely different figures. The seller's figures are likely skewed to his own advantage.
More tips on the next page:
A website's profits are rarely what they seem at first inspection >>