How to Calculate Goodwill For a Business

Know your Goodwill to Increase your Company’s Value

Goodwill is an important part of building your business and is one of the hardest things to calculate. Goodwill of a business is an intangible asset, hence calculating its value can be tricky depending on the business and its success. 

To understand Goodwill calculation, let us first know what is Goodwill?

Goodwill of a business is a premium or an additional payment that a business gets over and above the market value of its net assets. Some of the factors that decide the goodwill of your business are- 

• Reputation
• Brand Image/Identity
• Loyal Customer Base
• Talent in the company
• Positive cash flow with limited debt
• Growth Prospects

So how do we calculate Goodwill? Goodwill Calculation can be done by 2 simple methods mostly based on the income:

1. Goodwill Calculation using Average profits

This is one of the simplest methods to calculate goodwill of a business. The formula for this is:

• Goodwill= Avg. Profits x No. of Years

For e.g.- In this method calculate your average profits for the last 5 years and multiply it by 5. Taking 4-5 years as a ‘goodwill window’ for a company is safe enough as it takes that much time for a company to build its image

Make sure you are not calculating goodwill of a business based on years that have seen abnormal profits or losses.

2. The other method for Goodwill calculation is to compute the Market Valuation and subtract net assets from this figure

• Goodwill = Market Value- Net Assets
  

Get the business valued by an external accounting professional, financial expert or a business broker

Net assets include everything of value owned by the company, including property, inventory, vehicles, etc., minus any debts like bank loans or bonds

However if the payment includes things like stocks or a percentage of ownership in the company, the formula for goodwill calculation then becomes a little complicated:

• Goodwill = Consideration transferred + Amount of non-controlling interests + Fair value of previous equity interests - Net assets

Here Non-controlling assets refer to a certain percentage in the company which is not big enough to exercise any control

The methods mentioned above are the most common formulas of calculating goodwill of a business. Calculating goodwill becomes extremely important when one is looking to buy, sell, or bracing for a merger or acquisition of a business. However, it is always advisable to consult professionals before taking this decision.