Business worth- How do you calculate Goodwill?
Every business entity has a good will or credibility. Goodwill is an intangible asset and is determined by the company’s brand name, good customer relations, solid customer base, good employee relations and proprietary technology.
The calculation of good will arises when the company acquires another business. Its calculation is complex and can be undertaken by the professional accounting services in Delhi who value goodwill by using the appropriate methods.
Goodwill cannot be touched or seen but it can be traded and purchased and has a real value. Goodwill is the reputation earned by the business over the period of time. The valuation of goodwill is based on the assumption obtained by the valuer. A successful business earns an image in the industry, develops trust with its clients and has a good business links and name in the acumen. All these are taken into account with calculating goodwill.
Customers who buy a company looking at its goodwill hope to gain good profits. So goodwill applies only to the firms that make good profits and not to those who earn regular losses or profits. There are various methods of valuation of business worth or goodwill. However the valuation methods are based on the specific situation of the company and the varied trade practices. The top three methods of valuation of goodwill that the professional accounting services in Delhi works on while calculating the business worth are:
1. Average profit method: This method is divided into two subdivisions
a. Simple average: Here the goodwill valuation is done by multiplying the average profit by the number of years it is called years purchase.
b. Weighted average: In this method the last year profit is calculated by a specific number of weights. It is used to obtain the value of goods that is divided by the total number of weights for determining the average weight profit. This method is used when there is a change in profits and high value is given to the present year profits. Here goodwill is the weighted average profit is multiplied by the number of years of purchase, where the weighted average profit is the sum of profits multiplied weights and the figure so arrived is then divided by the sum of weights.
2. Super profit method: It is the surplus of expected future maintainable profits over the normal profits. It has two methods:
a. The purchase method by number of years: Goodwill is established by calculating super profits by a specific number of the purchase year. It is done by subtracting the average profit by the normal profit.
b. Annuity profit method: Here the average super profit is taken as an annuity value over a definite number of years. A discounted amount of super profit calculates the current value of an annuity at the given rate of interest. Goodwill is calculated by multiplying super profit with the discounting factor.
3. Capitalizations method: Here goodwill is calculated by two method:
a. Average profit method: In this method business worth is calculated by subtracting the original capital applied from the capitalized amount of the average profit based on the average rate of return.
b. Super profit method: Here the super profit is capitalized and the goodwill is calculated.
Based on the aforesaid methods of valuation, goodwill is valued by the professional accountants in a systematic manner and is shown under the head of intangible assets in the balance sheet.