Valuation of Goodwill: Meaning and Methods
Before we start with the meaning of valuation of goodwill, let us shortly evaluate the concept of Goodwill. The main intangible asset related to the acquisition of one company by another is goodwill. This portion of the purchase price, which is greater than the total net fair value of the acquired assets, is covered by this concept. The significance of goodwill can be understood by considering how important it is for boosting the value of the company. Additionally, it helps businesses attract more clients. In everyday speech, a company's goodwill is generally understood to be its proven track record.
What is the Valuation of Goodwill?
There are numerous factors that influence a company's goodwill. Such factors are more likely to include, among others, the capital requirement nature of the business, the market situation, the reputation of the owners, and profit trends.
The valuation of goodwill is based on the valuer's assumptions. In comparison to new companies, a successful business establishes a reputation in the industry, builds trust with its customers, and has more extensive business connections. All of these factors are considered when evaluating the business, and the financial value that a customer is eager to give is referred to as goodwill. Customers who purchase a company based on its goodwill expect to make huge profits. As a result, goodwill only applies to firms that make super-profits, not to those that earn regular losses or profits.
The requirement for valuation of goodwill comes from a range of different scenarios.
In Partnership: There is a need for goodwill valuation when partners retire, expire, or are newly admitted. It is also important in the event of changes in profit-sharing ratios or mergers.
In Company: A goodwill valuation would be required in the case of a company merger or acquisition of a controlling interest.
In Sole Proprietorship: The valuation of goodwill is required in a variety of situations, including purchase considerations of the sale of a business.
Methods of Valuation of GoodWill
Goodwill can be valued in a variety of ways. However, valuation methods are based on an individual company's situation and various trade practices. The top three processes for valuing goodwill are listed below.
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Average Profits Method
This method is divided into two parts.
Simple Average: In this process, goodwill is analysed by multiplying the average profit by the number of years purchased. This is the formula used to calculate it
Average Profit x Number of years of purchase = Goodwill
Weighted Average: A specific number of weights are used to calculate last year's profit. It is used to determine the average weight profit by calculating the value of goods and dividing it by the total number of weights. This technique is used when there has been a change in profits and a high focus is placed on the current year's profit. The formula is used to evaluate it
Weighted Average Profit x Number of Years of purchase = Goodwill, Total Profits multiplied by weights/ Total weights = Weighted Average Profit
2. Super Profits Method
It is the difference between normal profits and expected future maintainable profits. These are the two parts of this method.
The Purchase Method by No. of years: Goodwill is calculated by multiplying super-profits by a specific number of the purchase year. The formula used is
Actual or Average Profit - Normal Profit = Super Profit
Annuity Method: In this case, the average super profit is estimated as an annuity value over a set number of years. A discounted amount of super profit determines the current value of an annuity at a given interest rate. The formula used is
Super Profit x Discounting Factor = Goodwill
3. Capitalisation Method
This method is also divided into two parts.
Average Profits Method: Goodwill is calculated by subtracting the original capital applied from the capitalised amount of average profits based on the average return rate.The formula applied in this is
Average Profits x (100/average return rate) = Capitalised Average profits
Super Profits Method: The super profit is capitalised here, as is the goodwill. The formula used is
Super Profits x (100/ Normal Rate of Return) = Goodwill
About Sapient Services
Sapient Services, the successor company to M/s Malhotra Associates, began operations in April 1988. Initially, the company provided survey and loss assessment, valuation of plant and machinery/Chartered Engineer certification, and third party and risk inspection. Sapient Services Pvt. Ltd. is currently Govt. Registered Valuers, Chartered Engineers, Insurance Surveyors and Loss Adjusters, Risk Inspection and Assessor, with high professional proficiency. Since its beginning seventeen years ago, the firm has handled over 15000 cases in Marine Cargo, Engineering, Fire surveys, and claims of various magnitudes, and it provides services to all four subsidiaries of General Insurance Corporation of India.
