Meaning of Goodwill:-
Goodwill is an intangible asset which places an enterprise at an advantage due to which the enterprise is able to earn higher profits without putting extra efforts.
According to Spicer and Pegler Goodwill may be said to be that element arising from the reputation, connections or other advantages possessed by a business which enables it to earn greater profits than the returns normally to be accepted on capital represented by the net tangible assets employed in the business.
Characteristics or Features of Goodwill:-
- It is intangible asset, i.e., it does not have physical existence, and has a value, i.e., it is not a fictitious asset.
- It does not have an existence separate from that of an enterprise. Thus, normally it has realisable value when business or a part of business is sold.
- It helps is earning higher profits.
- It is an attractive force which brings in customers more frequently to the place of business.
- It comes into existence due to various factors such as locational advantages, favourable contracts, brands, trademarks, patents, market reputation, etc.
- Value of goodwill is subjective as it depends on the assessment of the valuer.
- In the context of partnership, it is the value of share of profit sacrificed by the sacrificing partner.
Factors Affecting The Value Of Goodwill:–
Goodwill is affected by the factors which increase the earning capacity of the firm. These are:
- Efficient Management – If the management is experienced, capable and competent, the firm will earn higher profits as compared to other firms.
- Favourable Location – If the business is located at a favourable place, resulting in increased customer walk-in and, therefore, increased sale and increased profit.
- Advantage of Patents – Normally, patents are necessary for the manufacture or production of certain types of articles. A firm which possesses the necessary patents will have a better value for its goodwill.
- Quality – If a firm enjoys good reputation for the quality of its products, there will be a ready sale and the value of its goodwill, therefore, will be high.
- Market Situation – If a firm is in a business wherein demand for the products dealt in is higher than the supply, it will lead to lower capital requirement and higher profit. It will, thus, increase the value of its goodwill.
- Nature of Business – If the business of a firm is of the nature where the products dealt in are in high demand although not short in supply, the profit will be higher. It will, thus, increase the value of its goodwill.
Method of Valuation of Goodwill:-
Value of goodwill is personal assessment of the valuer and is usually agreed among the partners. It is valued as per the method stated in the Partnership Deed or as per the method of valuation agreed by the partners. However, following three methods are followed for valuing goodwill:
- Average Profit Method
- Super Profit Method
- Capitalisation Method:
- Capitalisation of Average Profit Method
- Capitalisation of Super Profit Method.
Practical problem solutions
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