Valuation of Goodwill

Valuation of Goodwill

Meaning of Goodwill

Goodwill is the monetary value of good name and reputation of a business which distinguishes it from any other firm because of favourable situations such as location of business, quality of product, efficient management etc.

Factors affecting valuation of Goodwill

(i) Favourable location of the business

(ii) Quality of product

(iii) Efficient management

(iv) Favourable Government policies

Occasion when Goodwill is valued

(i) On change in profit sharing ratio of existing partners

(ii) On admission of a partner

(iii) On retirement or death of a partner

(iv) On amalgamation of two or more partnership firms

(v) On conversion of partnership firm into a company

Methods of Valuation of Goodwill

(i) Average Profit Method

Step - 1 Average Profit = Total Profit of given no. of years

No. of years

Step - 2 Goodwill = Average Profit ´ No. of years’ purchase

(ii) Super Profit Method

Step - 1 Normal Profit = Capital Employed ´ Normal rate of Profit

100

Step - 2 Super Profit = Firm’s Average Profit – Normal Profit

Step - 3 Goodwill = Super Profit ´ No. of years’ purchase

(iii) Capitalization Method.

(a) Capitalization of average profit

Step - 1 Capitalized Value = Firm’s Average profit ´ 100

Normal rate of profit

Step - 2 Goodwill = Capitalized Value – Capital Employed

(b) Capitalization of Super Profit

Step - 1 Normal Profit = Capital Employed ´ Normal rate of profit

100

Step - 2 Super Profit = Firm’s average profit – Normal profit

Step - 3 Goodwill = Super Profit ´ 100

Normal rate of profit