What is GOODWILL?
Goodwill means the good name or
wide business connections or reputations earned by a businessman through his
hard work and honesty. This helps the business to earn more profit. This means
good profit is the result of the reputation that, the business has build-up. In accounting, the monetary value
of such an asset is known as goodwill.
wide business connections or reputations earned by a businessman through his
hard work and honesty. This helps the business to earn more profit. This means
good profit is the result of the reputation that, the business has build-up. In accounting, the monetary value
of such an asset is known as goodwill.
Characteristics of
goodwill
·
It is an intangible
asset and not a fictitious asset.
It is an intangible
asset and not a fictitious asset.
·
It is the extra earning
capacity of the business.
It is the extra earning
capacity of the business.
·
It is an attractive
force, which brings customers to the old place.
It is an attractive
force, which brings customers to the old place.
·
It has a definite value.
It has a definite value.
·
Goodwill can not be sold
separately, because it does not have a separate existence.
Goodwill can not be sold
separately, because it does not have a separate existence.
·
Due to changing
circumstance, goodwill value may fluctuate from time to time that’s why the
valuation of goodwill is a difficult task.
Due to changing
circumstance, goodwill value may fluctuate from time to time that’s why the
valuation of goodwill is a difficult task.
Factors affecting the value of goodwill
1. Location of business :
If the business is at centrally
located place having customer traffic, results in high sales, thus increase in
goodwill.
located place having customer traffic, results in high sales, thus increase in
goodwill.
2. Types of business :
In case, it is a monopoly
business, where it is difficult for other firms to enter, the business will definitely
have excellent goodwill.
business, where it is difficult for other firms to enter, the business will definitely
have excellent goodwill.
3. Efficiency of management :
A well managed and efficient
business generally enjoys the advantage of high productivity and cost
efficiency therefore has more goodwill.
business generally enjoys the advantage of high productivity and cost
efficiency therefore has more goodwill.
4. Good quality of the product :
A business, which produces the best
quality of the product is likely to earn more profit and therefore the firm enjoy
good reputation.
quality of the product is likely to earn more profit and therefore the firm enjoy
good reputation.
5. Impressive publicity :
Effective and impressive
publicity and advertisement by the firm
will create demand for its products resulting and increased goodwill.
publicity and advertisement by the firm
will create demand for its products resulting and increased goodwill.
6. Favorable contracts :
If the contracts of the
firm has been with other reputed firms
and business houses or the firm has received bulk orders from highly reputed
firms, their goodwill increase tremendously.
firm has been with other reputed firms
and business houses or the firm has received bulk orders from highly reputed
firms, their goodwill increase tremendously.
7. trend of profit :
If the market conditions are
favorable, the profit of the business is increasing continuously, the value
of its goodwill will be more.
favorable, the profit of the business is increasing continuously, the value
of its goodwill will be more.
8. Personal popularity :
If the owners of the firm are
honest, sincere, customers friendly, diligent, hard-working and socially
cautious, the business will earn higher profit due to its popularity.
honest, sincere, customers friendly, diligent, hard-working and socially
cautious, the business will earn higher profit due to its popularity.
Methods of Valuation of goodwill
There are various method for
valuation of goodwill and these are:-
valuation of goodwill and these are:-
(A). Average profit method
This is a very simple and
widely followed method of valuation of goodwill. In this method, goodwill is
valued by taking into consideration the average profits of the last few years.
widely followed method of valuation of goodwill. In this method, goodwill is
valued by taking into consideration the average profits of the last few years.
Value of goodwill = average
profit × number of years of purchase
profit × number of years of purchase
(B). Super profit method
The term super profit means the
profit over and above the normal or average profit earned by similar firms.
profit over and above the normal or average profit earned by similar firms.
Super profit = average profit –normal
profit
profit
Where normal profit = capital
invested × normal rate of return/100
invested × normal rate of return/100
Goodwill = super profit ×
number of year purchase
number of year purchase
(C). Weight average profit method
This method is a modified version
of the average profit method.
of the average profit method.
Weighted average profit = total
of the product of profit/total of weight.
of the product of profit/total of weight.
And, goodwill = weighted average
profit × agreed number of the year purchased
profit × agreed number of the year purchased
(D). Capitalization method :
Under this method, the capital
value of business profit is to be found out. Capital value means to find out. Capital
value means to find out the capital needed to earn a fixed profit and on the
basis of this capital, goodwill is valued. There are two methods under the capitalization
method to valued goodwill.
value of business profit is to be found out. Capital value means to find out. Capital
value means to find out the capital needed to earn a fixed profit and on the
basis of this capital, goodwill is valued. There are two methods under the capitalization
method to valued goodwill.
These are:-
- Capitalization of average profit :
Goodwill = total value of the
business – net assets
business – net assets
And, total business/capitalized
value of business =average profit × 100/normal rate of return.
value of business =average profit × 100/normal rate of return.
- Capitalization of super profit :
Goodwill = total value of
business – net assets
business – net assets
Capitalization value of
business = super profit × 100/normal rate of return
business = super profit × 100/normal rate of return