Goodwill and Their Valuation

Goodwill is an intangible asset which is not visible and cannot be touched but can be purchased and traded.Goodwill consist many intangible assets like-Brand name,Customer base, Patents,Trademark,copyright etc.In other words, goodwill is a firm worth or reputation established over time.The valuation of goodwill is based on the assumption obtained by the valuer. A businessman work whole life to make its brand Successful, and this brand gives  business its desirable reputation in the market. This earned reputation evaluate the business, and its financial worth that a customer is eager to give is known as goodwill. This goodwill play a very important role in Mergers and Acquisitions.

 Valuation of Goodwill-

 Average Profits Method – This method is further divided into two sub-parts.

    Simple Average – In this process, goodwill evaluation is done by calculating the average profit by the number of years it is called years purchase. It can be calculated by using the formula.

 Goodwill = Average Profit x No. of years of purchase.

    Weighted Average – Here, last year’s profit is calculated by a specific number of weights. It is used to obtain the value of goods, which is divided by the total number of weights for determining the average weight profit. This technique is used when there is a change in profits and giving high importance to the present year’s profit. It is evaluated by using the formula. 

Goodwill = Weighted Average Profit x No. of years’ of purchase Weighted Average Profit = Sum of Profits multiplied by weights/ Sum of weights

 Super Profits Method – It is a surplus of expected future maintainable profits over normal profits. Under this method we have two more methods

    The Purchase Method by Number of Years – The goodwill is established by evaluating super-profits by a specific number of the purchase year. It can be estimated by applying the below formula. 

Super Profit = Actual or Average profit – Normal Profit

    Annuity Method –Here, the average super profit is taken as an annuity value over a definite number of years. A discounted amount of super profit calculates the current value of an annuity at the given rate of interest.

Goodwill = Super Profit x Discounting Factor

 Capitalization Method – Under this method, goodwill can be evaluated by  using these two methods.

    Average Profits Method – In this process, goodwill is measured by subtracting the original capital applied from the capitalized amount of the average profits based on the average return rate. 

 Capitalized Average profits = Average Profits x (100/average return rate)

    Super Profits Method- Here, the super profit is capitalized, and the goodwill is calculated.  

Goodwill = Super Profits x (100/ Normal Rate of Return)