What is goodwill?
As explained by Investopedia, goodwill is looked at as an ethereal asset on the balance sheet for it is not a physical asset like equipment and buildings. Generally, goodwill represents the value of intangible assets like good customer relations, strong brand name, good employee relations, and any kind of patents or proprietary technology. Goodwill generally arises at the time of one company being purchased by another.
Goodwill is, therefore, something which cannot be described easily but in general refers to good name, reputation, and wide ranging business connections which are helpful for the business in gaining more profits than what could have been otherwise earned. Moreover, goodwill is an attractive force aiming at bringing back the customers to old place of business.
Methods to evaluate goodwill
The methods used for valuation of goodwill of a firm are mentioned below:
- Average profit method
This method of goodwill valuation takes the average profit of previous years as its basis. This average profit is multiplied by the number of purchases made in that year.
Goodwill = Average Profit x Number of Purchases in the year
- Weighted average profit method
This method of goodwill evaluation can be explained as a modified side of the he average profit method. This method involves the relevant number of weights, i.e. 1, 2, 3, 4 multiples profit of each year so as to find out value product. The total of products is thereafter divided by the total of weights so as to calculate the weighted average profits.
Goodwill = Weighted Average Profits x No. of years Purchase Weighted Average Profit = Total of Products of Profits/ Total of Weights
- Super profit method
Super profit refers to a situation where in the actual profit is higher than what is expected. Under this method,
Goodwill = super profit x number of years’ purchase
- Capitalization of average profit method
As per this method,
Goodwill = Capitalized Value the firm - Net Assets Capitalized Value of the firm = Average Profit x 100/ Normal Rate of Return Net Assets = Total Assets - External Liabilities
- Capitalization of super profit method
Under this method, goodwill is calculated as:
Goodwill = Super Profit x 100/Normal Rate of Return