What Is Goodwill?
Goodwill is an intangible asset (an asset that’s non-physical which has the potential to offer long-term value). It is the monetary valuation of the business in terms of its reputation.
Goodwill is the value of the reputation of a firm in respect of the profits which are expected in future over and above the normal profits.
From the accountant’s point of view goodwill maybe said to be that element which arises from the reputation or other benefits possessed by a business which enable it to earn higher profits than the return which are normally expected on the capital by the net tangible assets put into the business.
Goodwill is an intangible asset which is attached to profits which are over and above what one can earn by starting a new business venture.
Goodwill plays an important role in strengthening the fundamentals and overall image of the business organisation, it is an intangible asset but not a fictitious asset which means that it has some realisable value.
Goodwill helps a business to get advantage over a new business in the market. It helps organisations create extra profit which is also known as super profit.
Goodwill is the measurement of reputation of the business in terms of money.
Goodwill is sometimes reported on the balance sheet with a description title which says that “excess of acquisition cost over net assets acquired”.
The following factors are responsible for the possession of Goodwill:
The Place of Distribution: The distribution channel also known as the location of the business premises, plays an integral role in development of goodwill in the long run. Creation of a right product at the right price is important but it’s ultimate distribution becomes the game changer. Businesses need to make the product available to its target customers at the right place, the place of distribution should be accessible to its potential buyers.
Product: The nature of the firm’s product or the reputation of the delivery of its services. Creating a strong and impactful product image is an essential factor to be taken into consideration.
Reputation: Personal reputation of its promoters and the company’s management play a significant role in impacting the organisation’s goodwill in the long run.
Human Resource Management: The recruitment and retention of efficient and sharp employees is a crucial factor. Businesses need to recruit and retain the employees who truly value the ethics of their business and strive to give the best for the organisation. The concept of right people at the right place add value to the business as it is to be taken into consideration. For achieving it’s optimum potential and success, the business entity has to necessarily recruit the right people, train them well, develop their skills and run retention programs. The people from the management, right from the top level to the lower level play a significant role and decide the destiny of the organisation.
Intagible Elements: The position of various intangible assets such as trade marks, patents, copyrights, its own strong impactful business name.
Promotional Activities: The constant efficient efforts of advertising campaigns. The activities undertaken in order to communicate and promote the product to the target audience. It includes advertising, public relations, sales promotions, direct marketing, and other communication efforts aimed at creating awareness and generating demand for the product.
Service/Customer Oriented Approach: The persistent attitude of the business towards delivery the best products or services to its ultimate clients. They must be carried on effectively and efficiently in order to reach its target marget and build a good reputation. The advancement of technology helps businesses to effectively monitor the procedures involved and to take necessary actions, if any, whenever and wherever necessary. Effective and time efficient procedures help organisations create goodwill in the long run.
Corporate Social Responsibility: Meeting various environmental protocols, legal compliance from time to time and working towards the betterment of the economy at large.
High Standards: The maintenance of the quality of the firm’s products and services and development of the business with the changing economic and global conditions. Businesses must stive to keep higher standards in terms of the growth of their organisation and the society at large. The focus must be on the company’s fundamental factors, profit maximisation strategies, cost reduction/efficient methods, ethical tax planning, recruitment and retention of efficient employees, creating a strategic roadmap relating to the organisation’s future business success plan and working diligently towards the improvement of the business, society and the global economy at large.
Need for evaluation of goodwill:
- When a business or a company is sold to another company or when a company is to be amalgamated with another company. Goodwill is required to be computed at the reconstruction, reconstitution, absorption, amalgamation of the business inorder to find out the true and fair value of the firn’s Goodwill.
- When stock exchange quotations are not available the equity shares need to be assigned a certain value for taxation purposes.
- While transacting a block deal of shares.
The following factors are to be considered in valuation of goodwill:
- Nature of the industry, it’s trends in the past and the risk which it is subject to.
- The future financial estimations and forecasts of the specific industry.
- The specific company’s history, it’s past performance and its records of the past profits, dividends paid out, various appropriations, expenditures undertaken, etc.
- The basis of valuation of the assets of the company and their book values.
- The ratio of liabilities to capital.
- The structure in which the company’s management performs.
- The capital structure prevalent within the company.
- Location, service utility, size and reputation of the company’s goods and services.
- The computation of the incidence of tax.
- The number of shareholders of the organisation
- To perform a comparative analysis systematically there needs to be a thorough check on the yield of shares of companies engaged in the same industry which are listed in the stock exchange.
- Major factor of computing the true and fair valuation of goodwill is the profits of the company. The profits which are expected to be generated in future are extremely important for the computation of goodwill. Various abnormal losses and gains are deducted to keep the profits at a normal rate.The following are the important factors which I have a significant impact on future profits; the personal expertise of the management, the nature of the business, distribution channel, copyright and trademark protection, ultimately favourable business contracts, capital structure and its arrangement.
- Market reputation, if any, which the company and management of the organisation has possessed overtime.
- Returns which are generally expected by investors within the same industry to which the company belongs to. Professional experts compute the yield/return of any specific company by taking into consideration the Normal Rate of Return prevalent within the industry and divide it with the return given by the particular company.