Valuation of Goodwill

Last updated: 01 November 2011

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Meaning of Goodwill :

In a simple terms the word goodwill means a “reputation” in accounting terms the goodwill means the extra profit available to concern due to various factors i.e. location , Specialized product, nature of business etc..

In short goodwill means Present value of Expected Future Earnings. It is the difference between the value of business as a whole & fair value of net separable assets .

Circumstances requiring the value of goodwill.

In following circumstances one has to compulsory value goodwill :

a) At the time of Conversion of firm in to limited company

b) At the time of Amalgamation, Merger, Acquisition

c) Sale of business etc..

Future Maintainable Profit (F.M.P)

Before calculating the goodwill , one has to first calculate the F.M.P

It is very complicated task. Valuer has to take in to consideration the Average Adjusted Past Profit & various economic factor which has got crucial impact on the concern. It is nothing but continuation of Past Profit in future .While calculating the F.M.P one has to eliminate the Abnormal income & expenditure.

Capital Employed

It is also called as Net Tangible Assets (NTA) .While calculating the Capital Employed only trading assets & investments to be taken into consideration .Capital employed is to be considered only on certain date so it is better to calculate Average Capital Employed during the year.

Normal Rate Of Return (N.R.R)

It is nothing but average return earned by the industry.

Method for valuation of Goodwill :

Basically, there are four method for valuation of goodwill :

a) Number of Years Purchase of Future Maintable Profit (F.M.P)

b) Capitalisation of F.M.P

c) Number of Years Purchase of Super Profit

d) Annuity Value of Super Profit.

Formula for valuation of Goodwill by said different methods :

a) Number of Years Purchase of Future Maintable Profit (F.M.P)

Goodwill = No. of Years Purchase x F.M.P

b) Capitalisation of F.M.P