How to decide the Goodwill?

[sakirehman]

Goodwill is the parameter of the company's performance. It is said that in simple term goodwill means "Business's capability to generate the profit". How we can evaluate the Goodwill of any existing company?

 

[UK Contractor Accountant]

Why do you need to value goodwill? Normally it is only recognised when buying a business and is the balancing figure between the sale price and the net asset value of the business.

There are various techniques associated with the valuation of goodwill which can be split into the three most common:


1. Simple multiple approach - The simple multiple approach is more appropriate for small, straight-forward businesses (typically owner-managed businesses). In a nutshell the way this works is to apply a multiple to sustainable profits before management/owners' remuneration. The range of multiples used in the calculation of goodwill usually varies between one and five. Typically where a business is showing strong growth and is experiencing high levels of profitability, the multiples used will be at the higher end of the scale. On the flip side, if a business is in decline, the multiples used will typically be at the lower end.


2. Turnover approach- This method is commonly used in a professional practice (such as when an accountancy or solicitors' practice is being sold). Multiples are then applied to these fees which are usually between 0.5 and 1.5 - though of course such ranges are often subjective and will depend on various factors such as the quality of the clients, financial health of the business and historical trends. As with the simple multiple approach, a business that is experiencing a higher level of growth will often have a higher multiple applied to it - this can sometimes be as high as 2.5 for a business that is experiencing a high degree of profitability and growth and as low as 0.25 for a business in decline.

3. Whole company approach -This is generally a very common approach to valuing goodwill. It works by valuing the entire business and then deducting tangible/intangible assets to find the residual amount which is the goodwill. In a nutshell, the whole company approach works by basing the valuation on a multiple that is applied to sustainable profit. Where this results in a valuation that is less than the adjusted net asset value, the assumption is that there is little (or even no) goodwill inherent in the business. The calculation uses a P/E ratio which is basically the relationship between after-tax profits of a business and its capitalised value. P/E ratios are often adjusted to take into account any 'one-off' items such as one-off bonus payments to directors or other exceptional items.

 

[Mitchells Bristol]

Why do you need to value goodwill?

I think for a homework assignment