goodwill valuation

GOODWILL

Used to describe the 'good name' or 'reputation' earned by a firm as it trades.

To express the intangible but quantifiable "prudent value" of an ongoing business beyond its assets.

The value of an entity over and above the value of its assets.

The difference between the purchase price and the sum of the fair value of the net assets is by definition the value of the "goodwill" of the purchased company.

Hopefully have a positive impact on the future turnover and profits of the business.

2/12/2012 A Presentation By Himanshu Arya,

Daksh Professional Education Meerut Mobile:+91- 9760-888-626

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CHARACTERISTICS OF GOODWILL

It belongs to the category of intangible assets. It is a valuable asset. It contributes to the earning of excess profits. Its value is liable to constant fluctuations. Its value is only realised when a business is sold

or transferred. It is difficult to place an exact value on goodwill

and it will always involve expert judgement. There can be effect of personal ability for

valuation of goodwill.



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KEY FACTORS AFFECTING GOODWILL The nature of the business. The goodwill relating to a service based

business is likely to be different than that of a manufacturing business.

Favorable location. If a business is situated in a good location it will generally have a positive affect on the value of goodwill.

Longevity of the business. If a business has been trading for a long period it may have had more time to develop a good solid reputation, and more goodwill.

Possession of licenses or technical know- how. After sales services and general customer care. Business risk involved. Future competition and new entrants into a specific business

marketplace. Management's attitude towards the fulfillment of commitments.



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NEED OF VALUATION OF GOODWILL

When the business is sold as a going concern.

When the business is amalgamated with another firm.

When business is converted into private or public company.

When there is a change in the profit-sharing ratio amongst the existing partners.

When a new partner is admitted.

When a partner retires or dies or reconstruction.

2/12/2012

A Presentation By Himanshu Arya, Daksh Professional Education Meerut

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GOODWILL VALUATION • Average Profit Method Past Profits of a number of years are taken into consideration.

Average Profit = Total Profits/ No. of Years Goodwill = Average Profit * No. of Years Purchased Why Average Profit & No. of Years Purchased

A buyer wishes to get advantage of it in future, that is uncertain. The estimate for the future depends upon the past performance. Profits in future depends upon its Average Performance in past. For some years to come the business will earn profit entirely due

to seller’s efforts. Hence, The buyer compensates the seller for the few years profit which

the buyer gets because of seller’s efforts.



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GOODWILL VALUATION

• Calculation of Average Profit

Profit of the year ADD : Abnormal Loss Income that will arise in future Expenses that will not occur in future LESS : Abnormal Gain Non-Operating Income Remuneration to the Proprietors Income that will not arise in future Expenses that will occur in future Income Tax



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GOODWILL VALUATION

• Weighted Average Profit Method • Past Profits of a number of years are taken into

consideration. • Weighted Average Profit = Total of Products/ Total of Weighted • Goodwill = Weighted Average Profit * No. of Years Purchased

• Why Weighted Average Profit • It gives weightage to latest profit which is likely to be

maintained in the future. It is applicable when profits shows sufficient Rising or

Falling trend. In case of Rising- more weightage is given to Recent years. In case of Falling- more weightage is given to Past years.



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GOODWILL VALUATION

• Super Profit Method

It assumes that if a business earns Super Profit, it has a goodwill, otherwise not.

Super Profit = Actual Average Profit – Normal Profit Where,

Normal Profit = Average Capital Employed * Normal Rate of Return

Normal Rate of Return = current Interest Rate + Risk Factor Rate

Goodwill = Super Profit * No. of Years Purchased



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GOODWILL VALUATION

• Net Capital Employed =

Tangible Fixed Assets at Market Value

+ Intangible Assets at Realisation Value

+ Current Assets at Market Value

- All Outside Liabilities



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GOODWILL VALUATION

From Assets Side: Tangible Fixed Assets (Included) such as Land & Building,

Plant & Machinery, Furniture. Intangible Assets (Included) such as Patent, Trade-Marks,

Copyrights. Current Assets (Included) such as Cash in Hand, Cash at

Bank, Sundry Debtors, B/R Goodwill (Excluded) Investment (Excluded) Fictitious Assets (Excluded) such as Preliminary Exp., Advt.

Exp., Underwriting Commission, Discount on Issue of Shares or Debentures, Dr. Balance of P&L A/C.

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GOODWILL VALUATION

From Liabilities Side:

Outside Liabilities (Deducted) such as Debentures, Creditors, Loan, Bank Overdraft, B/P, Provision for Income Tax.

Share Capital (Excluded)

Reserves & Surplus (Excluded)

Credit Balance of P&L A/C (Excluded)

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GOODWILL VALUATION

• Average Capital Employed = Capital Employed in the beginning + Capital Employed in the end

2 Capital Employed in the end = Capital Employed in the beginning + Net Profit of the year Hence We can write,

or Capital Employed in the end - Current Year’s Profit

2

or Capital Employed in the beginning + Current Year’s Profit

2



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GOODWILL VALUATION

• Capitalisation of Average Profit Method Actual Average Profit is capitalised at Normal Rate of Return.

It tells us, How much capital is needed for earning this Actual Average Profit.

Capitalised Value of Average Profit =

100

X Actual Average Profit

Normal Rate of Returns

Goodwill = Capitalised Value of Average Profit – Actual Capital Employed



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GOODWILL VALUATION

• Capitalisation of Super Profit Method This method tries to access the Capital needed for earning

the Super Profit.

It tells us, How much capital is needed for earning the Super Profit.

This Capital is known as Goodwill.

Goodwill =

100

X Super Profit

Normal Rate of Returns

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