Goodwill valuation

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  • 1. GOODWILL Used to describe the good name or reputation earned by a firm as it trades. To express the intangible but quantifiable "prudent value" of an ongoing business beyond its assets. The value of an entity over and above the value of its assets. The difference between the purchase price and the sum of the fair value of the net assets is by definition the value of the "goodwill" of the purchased company. Hopefully have a positive impact on the future turnover and profits of the business. A Presentation By Himanshu Arya, 2/12/2012 Daksh Professional Education Meerut 1 Mobile:+91- 9760-888-626
  • 2. CHARACTERISTICS OF GOODWILLIt belongs to the category of intangible assets.It is a valuable asset.It contributes to the earning of excess profits.Its value is liable to constant fluctuations.Its value is only realised when a business is sold or transferred.It is difficult to place an exact value on goodwill and it will always involve expert judgement.There can be effect of personal ability for valuation of goodwill. A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 2 Mobile:+91- 9760-888-626
  • 3. KEY FACTORS AFFECTING GOODWILL The nature of the business. The goodwill relating to a service based business is likely to be different than that of a manufacturing business. Favorable location. If a business is situated in a good location it will generally have a positive affect on the value of goodwill. Longevity of the business. If a business has been trading for a long period it may have had more time to develop a good solid reputation, and more goodwill. Possession of licenses or technical know- how. After sales services and general customer care. Business risk involved. Future competition and new entrants into a specific business marketplace. Managements attitude towards the fulfillment of commitments. A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 3 Mobile:+91- 9760-888-626
  • 4. NEED OF VALUATION OF GOODWILL When the business is sold as a going concern. When the business is amalgamated with another firm. When business is converted into private or public company. When there is a change in the profit-sharing ratio amongst the existing partners. When a new partner is admitted. When a partner retires or dies or reconstruction. A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 4 Mobile:+91- 9760-888-626
  • 5. GOODWILL VALUATION• Average Profit MethodPast Profits of a number of years are taken into consideration.Average Profit = Total Profits/ No. of YearsGoodwill = Average Profit * No. of Years PurchasedWhy Average Profit & No. of Years Purchased A buyer wishes to get advantage of it in future, that is uncertain. The estimate for the future depends upon the past performance. Profits in future depends upon its Average Performance in past. For some years to come the business will earn profit entirely due to seller’s efforts. Hence, The buyer compensates the seller for the few years profit which the buyer gets because of seller’s efforts. A Presentation By Himanshu Arya, 2/12/2012 Daksh Professional Education Meerut 5 Mobile:+91- 9760-888-626
  • 6. GOODWILL VALUATION• Calculation of Average Profit Profit of the yearADD : Abnormal Loss Income that will arise in future Expenses that will not occur in futureLESS : Abnormal Gain Non-Operating Income Remuneration to the Proprietors Income that will not arise in future Expenses that will occur in future Income Tax A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 6 Mobile:+91- 9760-888-626
  • 7. GOODWILL VALUATION• Weighted Average Profit Method• Past Profits of a number of years are taken into consideration.• Weighted Average Profit = Total of Products/ Total of Weighted• Goodwill = Weighted Average Profit * No. of Years Purchased• Why Weighted Average Profit• It gives weightage to latest profit which is likely to be maintained in the future. It is applicable when profits shows sufficient Rising or Falling trend. In case of Rising- more weightage is given to Recent years. In case of Falling- more weightage is given to Past years. A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 7 Mobile:+91- 9760-888-626
  • 8. GOODWILL VALUATION• Super Profit MethodIt assumes that if a business earns Super Profit,it has a goodwill, otherwise not.Super Profit = Actual Average Profit – Normal ProfitWhere,Normal Profit = Average Capital Employed * Normal Rate of ReturnNormal Rate of Return = current Interest Rate + Risk Factor RateGoodwill = Super Profit * No. of Years Purchased A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 8 Mobile:+91- 9760-888-626
  • 9. GOODWILL VALUATION• Net Capital Employed = Tangible Fixed Assets at Market Value+ Intangible Assets at Realisation Value+ Current Assets at Market Value- All Outside Liabilities A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 9 Mobile:+91- 9760-888-626
  • 10. GOODWILL VALUATION From Assets Side: Tangible Fixed Assets (Included) such as Land & Building, Plant & Machinery, Furniture. Intangible Assets (Included) such as Patent, Trade-Marks, Copyrights. Current Assets (Included) such as Cash in Hand, Cash at Bank, Sundry Debtors, B/R Goodwill (Excluded) Investment (Excluded) Fictitious Assets (Excluded) such as Preliminary Exp., Advt. Exp., Underwriting Commission, Discount on Issue of Shares or Debentures, Dr. Balance of P&L A/C. A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 10 Mobile:+91- 9760-888-626
  • 11. GOODWILL VALUATIONFrom Liabilities Side: Outside Liabilities (Deducted) such as Debentures, Creditors, Loan, Bank Overdraft, B/P, Provision for Income Tax. Share Capital (Excluded) Reserves & Surplus (Excluded) Credit Balance of P&L A/C (Excluded) A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 11 Mobile:+91- 9760-888-626
  • 12. GOODWILL VALUATION• Average Capital Employed =Capital Employed in the beginning + Capital Employed in the end 2Capital Employed in the end = Capital Employed in the beginning + Net Profit of the yearHence We can write,or Capital Employed in the end - Current Year’s Profit 2or Capital Employed in the beginning + Current Year’s Profit 2 A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 12 Mobile:+91- 9760-888-626
  • 13. GOODWILL VALUATION• Capitalisation of Average Profit Method Actual Average Profit is capitalised at Normal Rate of Return. It tells us, How much capital is needed for earning this Actual Average Profit. Capitalised Value of Average Profit = 100 X Actual Average Profit Normal Rate of ReturnsGoodwill = Capitalised Value of Average Profit – Actual Capital Employed A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 13 Mobile:+91- 9760-888-626
  • 14. GOODWILL VALUATION• Capitalisation of Super Profit Method This method tries to access the Capital needed for earning the Super Profit. It tells us, How much capital is needed for earning the Super Profit. This Capital is known as Goodwill. Goodwill = 100 X Super Profit Normal Rate of Returns A Presentation By Himanshu Arya,2/12/2012 Daksh Professional Education Meerut 14 Mobile:+91- 9760-888-626