Before delving into the definition of goodwill valuation, let us first define Goodwill. Goodwill is the most important intangible asset associated with the acquisition of one company by another. This concept applies to the portion of the purchase price that is greater than the total net fair value of the acquired assets. The importance of goodwill can be understood by considering how important it is for increasing the company's value. It also assists businesses in attracting more customers. In common parlance, a company's goodwill is understood to be its proven track record.
What is the Valuation of Goodwill?
A company's Valuation of goodwill is influenced by a variety of factors. Such factors are more likely to include, among other things, the nature of the business's capital requirements, the market situation, the reputation of the owners, and profit trends.
The valuer's assumptions are used to determine the value of goodwill. A successful business sets up a reputation in the industry, builds trust with its customers, and maintains more extensive business connections than a new company.
All of these factors are taken into account when evaluating a business, and the monetary value that a customer is willing to give is referred to as goodwill. Customers who buy a company based on its reputation expect to make a lot of money. As a result, goodwill only applies to companies that make super-profits, not to companies that make regular losses or profits.
The need for goodwill valuation arises from a variety of circumstances.
In Partnership: When partners retire, expire, or are newly admitted, there is a need for goodwill valuation. It is also important in the event of profit-sharing ratio changes or mergers.
In Company: In the case of a company merger and acquisition of a controlling interest, a goodwill valuation would be required.
In Sole Proprietorship: In a sole proprietorship, goodwill must be valued in a variety of situations, including purchase considerations and the sale of a business.
Valuation of Goodwill: Calculation Methods
Average Profit Method
The average profit method computes an average profit over the previous three to four years, ignoring any unusual profit or loss. The calculated average profit will be multiplied by the number of years agreed upon, say 4 or 5. The resulting figure is the value of goodwill.
The weighted profit method is a modified version of the average profit method in which a predetermined weightage is multiplied by each year's profit as well as divided by the total number of weights to calculate the average weighted profit, that is then multiplied by the predetermined number of years of purchase.
Super Profit Method
The super profit method multiplies the super profit by the number of years agreed upon. Profit that exceeds normal profit is referred to as super profit. It is calculated by subtracting normal return from future maintainable profit (calculated by multiplying capital employed by normal return rate). The super profit is multiplied by the agreed-upon number of years of purchase to calculate the goodwill amount.
Annuity Method
The present value of the company's future super-profits is used to calculate goodwill in this method. As a result, multiplying super profits by the annuity factor yields the present value of goodwill.
Capitalisation Method
This method computes goodwill by deducting the actual capital employed from the capitalised average profit based on a normal rate of return, or by simply dividing super profit by the agreed capitalization rate. As a result, the following are the two options for calculating goodwill under this method.
Average Profit Capitalization Method: [Average profit/ normal rate of return* 100]- capital employed = Goodwill
Super Profit Capitalization Method: Goodwill – Super profit/ capitalization rate* 100
Influencing Factors
The following factors influence goodwill valuation during a business combination:
- The nature of the business and its location influence the valuation of goodwill. If the company is in a good location, it will have more goodwill.
- Longevity, or the length of time the company has been in operation, also influences how much goodwill is valued. The stronger the company's market presence, brand name, and goodwill valuation, the older it is.
- Goodwill is also valued based on the quality of the products and services, customer trust, and customer base.
- The valuation of goodwill is affected by licensing, technical know-how, customer service, after-sales services, as well as the business risk involved.
- Profitability, capital employed, market competitors, management methods for meeting investor expectations, and other factors all have an impact on goodwill.
About Sapient Services
Sapient Services, M/s Malhotra Associates' successor company, began operations in April 1988. Initially, the company issued survey as well as loss assessment, valuation of plant and machinery/Chartered Engineer certification, third party and risk inspection, and third party and risk assessment.
Sapient Services Pvt. Ltd. is currently a government-registered valuer, chartered engineer, insurance surveyor and loss adjuster, risk inspector and assessor, and risk assessor. The firm has handled over 15000 cases in Marine Cargo, Engineering, Fire surveys, as well as claims of various magnitudes since its inception seventeen years ago, and it provides services to all four subsidiaries of General Insurance Corporation of India.
