Valuation of goodwill by Ruby Sharma


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  • I want to know goodwill value for a bussiness , detail as below. 1. Industry Manufacturing spare parts 2. Industry is propritor ship starts in 1985 3. Reason for valuation of goodwill:- Want to sold out complete bussiness. 3. Company is doing bussiness with only Govt. organisation like Coal India Ltd., NMDC , Neyveli Lignite. 4. orders are recievd only by quoting tenders & only on technical qualification and L1 basis 5. There are 5 to 10 compititors in market & cut through compition. 6. Last 5 year Bussiness turnover & book profit & actal profits are as below. Year Turnover Book Profit Actual 1 2014-15 210 Lakh 5.2 Lakhs 13.5 2 2013-14 185 Lakhs 4.8 14.2 3 2012-13 195 Lakhs 4.7 12.8 4 2011-12 165 Lakhs 4.3 12.6 5 2010-11 178 lakhs 4.2 11.5 6. This is technical bussiness required experties. Prasent owner is Engineers & having experties in this field. Purchaser in no technical person. 7. In this bussiness , if any technical mistake happen , product rejected or fail. Inspite of this technical experties ,yearly 5% to 7% failure is happen.
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  • A very informative and useful notes......thanks
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Valuation of goodwill by Ruby Sharma

  1. 1. Valuation OfGoodwill1Ruby Sharma
  2. 2. Meaning An intangible asset which provides a competitiveadvantage, such as a strong brand, reputation, orhigh employee morale.OR Goodwill is seen as an intangible asset on thebalance sheet because it is not a physical assetlike buildings or equipment. Goodwill typicallyreflects the value of intangible assets such as astrong brand name, good customerrelations, good employee relations and anypatents or proprietary technology.2Ruby Sharma
  3. 3. Features of Goodwill : (i) Goodwill can be sold only with the entire business or itcannot be sold in part or in isolation except on admissionor retirement of a partner when new partner.compensate the old partners or the retiring partner givesup his rights in favour of remaining partners. (ii) Goodwill is valuable only if it is capable of beingtransferred from one person to another. If it cannot betransferred then there will be no value of goodwill. (iii) Goodwill represents a non-physical value over andabove the physical assets. (iv) Goodwill cannot have an exact cost as its valuefluctuates from time to time due to internal or externalfactors which ultimately affect the fortune of theCompany. (v) The value of goodwill is based on subjectivejudgment of the valuer.3Ruby Sharma
  4. 4. Types of GoodwillPurchasedgoodwillNonpurchasedor raisedgoodwillGoodwill4Ruby Sharma
  5. 5. Types of Goodwill : Purchased goodwill arises only when a businessenterprise is acquired by another business enterprise andthe price paid is more than the net assets acquired. Suchgoodwill is recognized by the accounting profession and isalso shown in the Balance Sheet. The main features ofsuch goodwill are — (i) It arises only on purchase ofbusiness (ii) It is reflected by a purchase transaction (iii)Us cost could, depend upon the future maintainableprofits (iv) It can be shown in the Balance Sheet. Non purchased (or raised) goodwill arises only when abusiness generates its own goodwill over a period of limedue to various factors such as location, goodmanagement, good quality products etc. The mainfeatures of such goodwill are : (i) It is internallygenerated, (ii) No cost can be placed on it, (iii) Value ofgoodwill is based on the subjective judgement of thevaluer, (iv) It is not reflected by a purchaseconsideration, and (v) It is not shown in the BalanceSheet.5Ruby Sharma
  6. 6. Classes of Goodwill: According to Rowland, There are four principal classesof goodwill, viz., (1) Local, arising from the situation of the traderspremises, e.g., a retail shopkeeper in a busy marketcentre ; (2) The Personal Reputation of the individual, arisingthrough his skill, influence and personality, as in thecase of a professional man, e.g., an accountant or adoctor ; (3) The Reputation of the Goods Sold, arising from thehigh standard of quality of the goods soldthemselves, e.g., a well-advertised brand of proprietarygoods ; (4) The Absence of Competition, or the existence of anabsolute Or partial monopoly.6Ruby Sharma
  7. 7. Need for the Valuation ofGoodwill The valuation of the Goodwill of a soleproprietorship is done when thebusiness is being sold, but in case of apartnership firm and a joint stockcompany goodwill can be sold tosome another business entity withoutselling the whole business. Hencewhen you are going to sell thegoodwill of your business, you shouldbe assured of the value of yourgoodwill at that particular time.7Ruby Sharma
  8. 8. In case of a Partnershipfirm, 1) In the case of a change in the profitsharing ratio of the firm; 2) In case of admission of a newpartner; 3) In case of retirement or death of anold partner; 4) In case of Sale / amalgamation ofthe firm.8Ruby Sharma
  9. 9. In case of a Joint StockCompany, 1) In case of amalgamation of two ormore companies; 2) In case of taking over of business of acompany by another company; 3) In case of taking over the business ofthe company by Government; 4) In case of conversion of shares of oneclass into another; 5) If a company wants to acquire controlof another company;9Ruby Sharma
  10. 10. There are many factors that affect thevaluation of goodwill. They are as follows:1. Location: The business located in a suitable place commands moregoodwill than others.2. Capital: The more, the capital of business, the more chance of goodwill. Afirm with a high debt will have to pay more interest from profit of the firm andnaturally goodwill will be less.3. Nature Of Business: A firm with a constant sales has more chance ofearning profit and naturally goodwill too.4. Efficient Management: A good management brings more profits to thebusiness. Increase in the value of goodwill is the result of efficientmanagement.5. Contract :Firm may enter into a contract of sales for long period. A firm canmake more profit on sale of goods on that contract by making purchase onreasonable terms. This lead to increase in the value of goodwill.6. Patent Right :A firm having patent right for production of goods can earnmore goodwill than others.7. Quality Of The Product : A firm producing qualitative products can easilyhave name and fame in the market. This lead to increase in the value ofgoodwill.8. Other Factors : Besides the factors mentioned above, money marketcondition, peace in the country, governments policy, tendency of profit etc.also affects the valuation of goodwill. 10Ruby Sharma
  11. 11. Methods Use To ValueGoodwill: By an arbitrary assessment By a capitalization of expected futurenet profits or earnings By a certain number of years’purchase of past profits or earnings By super profits or earnings:Purchase of super profitAnnuity methodCapitalization of super profit method11Ruby Sharma
  12. 12. Arbitrary Assessment The valuation of goodwill is arrived at by making a valuation byone of the parties, i.e. vendor or purchaser to which the otheragrees. The parties may together estimate the value to be placedon the goodwill or an independent party may be called in to givehis opinion as to the value, it being left to the parties to decidewhether they will accept or reject such valuation. This method canbe used only when information relating to earning capacity isavailable. If this information is not available because of non-availability of the profit immediately prior to sale or if the profits areabnormal or unreliable then such profits cannot be used as a guideto future profits. Similarly information relating to earning capacitymay not be available if the business being acquired may beconverted into one of a different nature from that existing prior todate of purchase such as where a retail shop dealing in garmentsis purchased with a view to converting it to a pharmacy.Consideration should also be given to the question of tradingadvantages (e.g., quotas) made available to the purchaser by avendor and licenses to import goods up to authorized values.There are really no guides obtainable from the accounting data asto the valuation of such benefits passed on to the purchaser andtheir worth remains a matter of assessment to be agreed upon bythe parties.12Ruby Sharma
  13. 13. Average Normal ProfitsMethod Under this method goodwill is valuedon the basis of an agreed numberyears purchase of the average profit. Value of goodwill= (Avg. profit)(Agreedno of yr’s purchases)13Ruby Sharma
  14. 14. Weighted Average ProfitMethod: This method is the modified version of thesimple average profit method. Under thismethod each years adjusted profits aremultiplied with the respective number of weightsin order to calculate the total product. The totalof products is then divided by the total of weightsto calculate the weighted average profits.Thereafter the weighted average profits aremultiplied by the number of years of purchase. Weighted Average Profits = Total of Productsof profits/Total of weights Goodwill = Weighted average profits x No ofyears of purchase14Ruby Sharma
  15. 15. Super profits method:Under this method average super profit isascertained.The excess of estimated future profitsover normal profits is called super profit.In other words super profits representextra profits obtained by a firm incomparison with the normal rate of returnin the industry of which the firm is aconstituent part.Value of goodwill= (Avg. Superprofit)(Agreed no of yr’s purchases)15Ruby Sharma
  16. 16. Capitalization method There are two ways of calculatingGoodwill under this method: (i) Capitalization of Average ProfitsMethod (ii) Capitalization of Super ProfitsMethod16Ruby Sharma
  17. 17. Capitalization of AverageProfits Method: Under this method we calculate theaverage profits and then assess the capitalneeded for earning such average profitson the basis of normal rate of return. Suchcapital is called capitalized value ofaverage profits. The formula is:- Capitalized Value of Average Profits =Average Profits X (100 / Normal Rate ofReturn) Capital Employed = Assets - Liabilities Goodwill = Capitalized Value of AverageProfits - Capital Employed 17Ruby Sharma
  18. 18. Capitalization of SuperProfits Under this method first of all wecalculate the Super Profits and thencalculate the capital needed forearning such super profits on thebasis of normal rate of return. ThisCapital is the value of our Goodwill. Goodwill = Super Profits X (100/Normal Rate of Return)18Ruby Sharma
  19. 19. Annuity Method Goodwill= Annuity factor* super profit19Ruby Sharma