Goodwill is an intangible asset of the company. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill. To calculate goodwill, we should take the purchase price of a company and subtract the fair market value of identifiable assets and liabilities.
Goodwill = P−(A+L)
P = Purchase price of the target company
A = Fair market value of assets
L = Fair market value of liabilities.
Factors Affecting Goodwill
The following factors have an impact on the goodwill, They are:
- Location of the business: A business which is located in a suitable location will have a more favourable chance of higher goodwill than a business located in a remote location.
- Quality of goods and services: A business which is providing a higher quality of goods and services stands a great chance of earning more goodwill than competitors who provide inferior goods and services.
- The efficiency of management: Efficient management results in an increase in profit of the business which enhances the goodwill of the business.
- Business Risk: A business having lesser risk has a better chance of creating good-will than a high-risk business.
- Nature of business: It means the type of products that business deals with, the level of competition in the market, demand for the products and the regulations impacting the business. A business having a favourable outcome in all these areas will have greater good-will.
- Favourable Contracts: A firm will enjoy higher good-will if it has access to favourable contracts for the sale of products.
- Possession of trademark and patents: Firms that have patents and trademarks will enjoy a monopoly in the market, which will contribute to the increase in the good-will of the firm.
- Capital: A firm with a higher return on investment along with lesser capital investment will be considered by buyers as more profitable and have more good-will.
Need for Valuation of Goodwill
- The difference in the profit-sharing ratio (PSR) amongst the existing partners
- Admission of a new partner
- Retirement of a partner
- Death of a partner
- Dissolution of an enterprise involving the sale of the business as a trading concern
- Consolidation of partnership firms
Methods of Valuation of Goodwill
The significant methodologies of valuation are mentioned :
- Average Profits Method.
- Super Profits Method.
- Capitalisation Method.