What is Goodwill? What are the valuation methods of Goodwill?

Goodwill: It is an intangible asset . If a company pays more than the book value to purchase the company it is due to that goodwill of the company. The company earns goodwill by satisfying the needs of a customer, solving  customer grievances in fixed time, and provide services and product in reasonable prices etc. but all of this not happen in few time. Company earn super profit which means it earns more than normal profit due to its goodwill in a market. Newly established company does not earn goodwill because people don’t know about the company and they can’t trust in new company so easily in comparison to old and well established company who work in a market more years in comparison to new one. With the help of goodwill company gets well known in a market, easily gets the client for the company, profit earns more than normal, easily compete with the competitors.
So, it is necessary to ascertain the value of a company’s goodwill. If there is any acquisition, partnership and mergers are taken place in future.

Valuation of goodwill:

There are three types of goodwill valuation methods:

·         Average profit method

·         Super profit method

·         Capitalisation method

1.       Average profit method: It is divided into two parts:

·         Simple average profit: In this method the goodwill calculated with the help of average of past year profit of a company before calculated the average profit of the company first adjust the profit by adding the normal losses and abnormal gain and subtracting the normal losses and abnormal gain. And after that multiply average profit with number of years purchase.

Simple average profit method = adjusted profit / number of years

Goodwill = Average profit* number of years purchases

·         Weighted average method: under this method the profit of an each year multiplied with their assigned weights and then sum the product and after divide with total number of weights. And then the result is multiply with number of years purchases.

Weight average = Total of product of profit with weights / Total of weights

Goodwill = Weighted average of profit*Number of years purchase

2.       Super profit method: It is divided into 2 parts:

·         In this method super profit is calculated which indicate more than normal profit. First of all calculate normal profit and then subtract it from average profit to ascertain the super profit. To calculate the goodwill multiplies super profit with normal rate of return.

Super profit = Average profit – Normal profit

Normal profit = Capital employed * Normal rate of return

Capital employed = total assets-fictitious assets-outside liability

·         Purchase method: Under this method super profit is multiply with number of years purchase.

Goodwill = Super profit*Number of years purchase

·         Annuity method: Under this method super profit is multiply with present value of annuity.

Goodwill = Super profit*present value of annuity

3.       Capitalisation method: It is also divided into two parts:

·         Average profit method: To calculate the goodwill in capitalisation method first of all find out the average profit then divided by normal rate of return to get average capitalized value of business and after that subtract the result from the actual capital employed

Average capitalized value = {Average profit / Normal rate of return} *100

Goodwill = Average capitalized value of asset – Net asset or actual capital employed

·         Super profit method: Under this method super profit is divided with the normal rate of return.

Goodwill = Super profit * (100/Normal rate of return)