Goodwill is often a big part of a business's overall value, and one of the hardest to calculate. Unlike tangible assets such as equipment which is easier to value, it's not easy to put a price on the reputation you've built up with your customers and suppliers.
Goodwill is an additional payment for a business over and above the net assets (add up all the assets and deduct the liabilities). It tries to reflect you’re buying a business as a ‘going concern’, with things like existing cash flow, loyal customers, processes and supplier agreements and great staff already in place.
When you’re working out goodwill it’s likely to be more if the business has:
The better these are, the more goodwill. And vice versa of course.
It can be a complicated process, and different methods will give different results. Ultimately the value is what the marketplace or buyer is willing to pay, regardless of what you may think.
This is the simplest and a common method to calculate goodwill, where goodwill is equal to the average profits for a set time period, multiplied by the number of years you think the previous owner’s goodwill will last, i.e.,
Goodwill = Average Profits X Number of Years
Decide on an average profit over the last few years by reviewing the Profit and Loss Account. Check your numbers. Make sure that you take the following into account:
Estimate how long you believe the ‘goodwill’ of the current business will last. If the business is a ‘turn key’ business where it’ll make money for 3-5 years without you needing to change anything, then multiply the average profit by 3-5 to get a goodwill amount.
At the opposite end of the scale is a business which has either very low or no profit, or the business needs significant improvements. In this case the goodwill may be zero.
You don’t have to pay goodwill. If you’re buying the business and the goodwill is excessive, ask yourself if it would be cheaper and better to start from scratch. It just may well be.
There are a number of other methods such as:
The methods described are the most common ways to value goodwill in a business, for both buyers and sellers. However, you are best to seek the help of professionals such as specialist industry business brokers, accountants or business advisors to determine the best way to value goodwill.
POSTED IN: Succession,2017