how to calculate good will of a company

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how to calculate good will of a company ..

Answer / arjun k. v

The following are the methods of valuation of goodwill of a
firm: -

1.Average Profit Method
2.Weighted Average Profit Method
3.Super Profit Method
4.Capitalization of Average Profit Method
5.Capitalization of Super Profit Method
6.Present Value of Super Profits Method
1. Average Profit Method: Under this method goodwill is
calculated on the basis of the average profit of previous
years. The average profit is multiplied by the number of
year's purchase.

Goodwill = Average Profit x Number of Years Purchase

Example: Calculate goodwill at twice the average profits of
last four years' profits. The profits of the last four
years were:

1.Rs. 27,000
2.Rs. 39,000
3.Rs. 16,000 (Loss)
4.Rs. 40,000
Solution: Total Profit for last four years = Rs. 27,000+
Rs. 39,000-Rs. 16,000+Rs. 40,000 = Rs. 80,000

Average Profit = Rs. 80,000/4 = Rs. 20,000.

Goodwill = Rs. 20,000 x 2 = Rs. 40,000.

2. Weighted Average Profit Method: This method is a
modified version of the average profit method. Under this
method the respective number of weights i.e. 1,2,3,4
multiplies profit of every year, in order to find out value
product and the total of products is then divided by the
total of weights in order to ascertain the weighted average
profits.

Goodwill = Weighted Average Profits x No. of years Purchase

Weighted Average Profit = Total of Products of Profits/
Total of Weights

Example: Calculate goodwill at twice the weighted average
profits of last four years' profits. The profits of the
last four years were:

2001. Rs. 37,000
2002. Rs. 29,000
2003. Rs. 26,000
2004. Rs. 40,000

Solution:

Years
Profits
Rs.
Weight
Product
Rs.
2001
37,000
1
37,000
2002
29,000
2
58,000
2003
26,000
3
78,000
2004
40,000
4
1,60,000
Total
10
3,33,000
Weighted Average Profit = Rs. 3,33,000/10 = Rs. 33,300

Goodwill = Rs. 33,300 x 2 = Rs. 66,600

3. Super Profit Method: When the actual profit is more than
the expected profit or normal profit of a firm, it is
called 'Super Profit.' Under this method goodwill is to be
calculate of on the following manner:

Goodwill = Super Profit x Number of Years Purchase

Example: The books of a business showed that the capital
employed on January 1, 2001 was Rs. 4,50,000 and the
profits for the last five years were as follows: 2001-Rs.
40,000; 2002 -Rs. 50,000; 2003 - Rs. 60,000; 2004 -Rs.
70,000 and 2005 -Rs. 80,000.

You are required to find out the value of goodwill, based
on three years' purchase of the super profit of the
business given that the normal rate of return is 10%.

Solution: Total Profit of last five years = Rs. 40,000 +
Rs. 50,000 + Rs. 60,000 + Rs. 70,000 + Rs. 80,000 = Rs.
3,00,000

Average Profit = Rs. 3,00,000/5 =Rs. 60,000

Normal Profit = Rs. 4,50,000 x 10/100 = Rs. 45,000

Super Profit = Actual/Average Profit - Normal Profit

Super Profit = Rs. 60,000 - Rs. 45,000 = Rs. 15,000

Goodwill = Rs. 15,000 x 3 = Rs. 45,000.

4. Capitalization of Average Profit Method: Under this
method goodwill is difference between the total Capitalized
value of the firm and the net assets of the firm.

Goodwill = Capitalized Value the firm - Net Assets

Capitalized Value of the firm = Average Profit x 100/
Normal Rate of Return

Net Assets = Total Assets - External Liabilities

Example: A firm earns Rs. 65,000 as its average profits.
The usual rate of earning is 10%. The total assets of the
firm amounted to Rs. 6,80,000 and liabilities are Rs.
1,80,000. Calculate the value of goodwill.

Solution : Total Capitalized value of the firm = Rs. 65,000
x 100/10 = Rs. 6,50,000

Net Assets = Rs. 6,80,000 - Rs. 1,80,000 = Rs. 5,00,000

Goodwill = Total Capitalized value of the firm - Net Assets

Goodwill = Rs. 6,50,000 - Rs. 5,00,000 = Rs. 1,50,000.

5. Capitalization of Super Profit Method:

1.Calculate Capitalized value of the firm
2.Calculate required profit on capital employed by using
the following formula:
Normal Profit = Capital Employed x Required Rate of
Return/100

1.Calculate average profit
2.Calculate super profit
Goodwill = Super Profit x 100/Normal Rate of Return

Example: Verma Brothers earn a profit of Rs. 90,000 with a
capital of Rs. 4,00,000. The normal rate of return in the
business is 15%. Use Capitalization of super profit method
to value the goodwill.

Solution:

Normal Profit = Rs. 4,00,000 x 15/100 = Rs. 60,000

Super Profit = Rs. 90,000 - Rs. 60,000 = Rs. 30,000

Goodwill = Super Profit x 100/Normal Rate of Return

= Rs. 30,000 x 100/15 = Rs. 2,00,000

6. Present Value of Super Profit: Under this method,
goodwill is estimated as the present value of the future
super profits. The following steps are taken:

1.Calculate the future super profits for next years
2.Choose the required rate of return
3.Calculate present value factors
4.Multiply present value factors with future super profits
5.The sum of product of present value factors and super
profits is the value of goodwill.
Example: A firm has the forecasted profits for the coming 4
years as follows:

Years
Profits
Rs.
1
80,000
2
1,00,000
3
90,000
4
1,20,000
The total assets of the firm are Rs. 9,00,000 and outside
liabilities are Rs. 3,00,000. The present value factors at
10% are as follows:

Years
Present Value Factor
1
.9279
2
.8029
3
.7056
4
.6978
Calculate the Value of goodwill.

Solution:

Net Assets = Total Assets - Liabilities

= Rs. 9,00,000 - Rs. 3,00,000

= Rs. 6,00,000

Normal Profit = 10/100 x Rs. 6,00,000 = Rs. 60,000

Years
1
2
3
4
Profits (Rs.)

80,000
1,00,000
90,000
1,20,000
Normal Profit

60,000
60,000
60,000
60,000
Super Profit

20,000
40,000
30,000
60,000
Present Value Factor

.9279
.8029
.7056
.6978
Present Value of Super Profit

18,558
32,116
21,168
41,868
Goodwill = Rs. 18,558 + Rs. 32,116 + Rs. 21,168 + Rs.
41,868 = Rs. 1,13,710.