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.
Characteristics of goodwill
- It is an intangible asset and not a fictitious asset.
- It is the extra earning capacity of the business.
- It is an attractive force, which brings customers to the old place.
- It has a definite value.
- Goodwill can not be sold separately, because it does not have a separate existence.
- Due to changing circumstances, goodwill value may fluctuate from time to time that’s why the valuation of goodwill is a difficult task.
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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.
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.
3. Efficiency of management :
A well managed and efficient 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.
5. Impressive publicity :
Effective and impressive 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.
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.
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.
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Methods of Valuation of goodwill
There are various method for 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.
Value of goodwill = average 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.
Super profit = average profit –normal profit
Where normal profit = capital invested × normal rate of return/100 Goodwill = super profit × number of year purchase
(C). Weight average profit method
This method is a modified version of the average profit method.
Weighted average profit = total of the product of profit/total of weight. And, goodwill = weighted average 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. These are:-
1. Capitalization of average profit:
Goodwill = total value of the business – net assets And, total business/capitalized value of business =average profit × 100/normal rate of return.
2. Capitalization of super profit:
Goodwill = Total value of the business – net assets Capitalization value of business = super profit × 100/normal rate of return