Valuation of Goodwill
and Its Methods
Name – Aryahi Singh
Roll no – BCP/24/140
Section - A
Introduction to Goodwill
• Goodwill is an intangible asset.
• Represents brand value, reputation, customer loyalty, etc.
• Arises when a business is sold for more than the fair value of net assets.
Goodwill reflects the non-physical advantages a business has built over
time, such as customer trust, efficient workforce, or strong
supplier relations
Why Value Goodwill?
§ Business sale or acquisition
§ Change in partnership (admission, retirement, death)
§ Mergers and acquisitions
§ Legal or accounting requirements
Explanation
Valuing goodwill ensures fair compensation for the intangible
benefits when ownership or structure changes.
Methods of Valuation
§Average Profit Method
§Super Profit Method
§Capitalization Method
§Annuity Method
Explanation:
Each method suits different scenarios. The choice depends
on profit stability, industry comparisons, or the importance of
time value of money
Average Profit Method
Formula:
Goodwill = Average Profit × Years of Purchase
Steps:
[Link] past profits
[Link] by number of years → Average Profit
[Link] by the agreed number of years
Example:
Profits: ₹50k, ₹52k, ₹48k → Average = ₹50k
Years of purchase = 3
Goodwill = ₹50,000 × 3 = ₹150,000
Used When: Profits are relatively stable over the years.
Super Profit Method
Formulas:
Super Profit = Average Profit – Normal Profit
Normal Profit = Capital Employed × Normal Rate of Return (NRR)
Goodwill = Super Profit × Years of Purchase
Example:
Avg Profit = ₹60,000
Capital Employed = ₹400,000
NRR = 10% → Normal Profit = ₹40,000
Super Profit = ₹60,000 – ₹40,000 = ₹20,000
Goodwill = ₹20,000 × 3 = ₹60,000
Used When: Business earns more than normal industry returns.
Capitalization Method
Two Types:
a) Capitalization of Average Profit
Goodwill = (Average Profit × 100 / NRR) – Capital Employed
b) Capitalization of Super Profit
Goodwill = Super Profit × 100 / NRR
Example:
Avg Profit = ₹60,000, NRR = 10%
Capitalized Value = ₹600,000
Capital Employed = ₹450,000
Goodwill = ₹600,000 – ₹450,000 = ₹150,000
Used When: Long-term earning capacity and capital structure are key.
Annuity Method
Formula:
Goodwill = Present Value of Super Profits
= Σ (Super Profit / (1 + r)^n)
Where:
•r = Discount Rate
•n = Number of Years
Example:
Super Profit = ₹30,000
Duration = 3 years
Discount Rate = 10%
PV factor ≈ 2.49
Goodwill = ₹30,000 × 2.49 = ₹74,700
Used When: Time value of money is considered important
Key Terms & Ratios
Key Formulas & Definitions:
Average Profit = Total Profit / Number of Years
Capital Employed = Total Assets – External Liabilities
Normal Rate of Return (NRR): Industry benchmark return
Super Profit = Average Profit – Normal Profit
Years of Purchase: Agreed multiplier (usually 2–5 years)
Purpose: These ratios are essential to compute goodwill accurately
across all methods.
Conclusion
§Goodwill is critical in assessing a business's true worth.
§Choice of method depends on stability of profits and context.
§Accurate valuation ensures fair dealing in business
transitions.
Goodwill isn’t just an accounting figure — it reflects the
unseen but real strengths of a business.
