How can the value of goodwill be determined?
There are a number of methods for valuing goodwill. At least one or more will be pertinent depending upon the facts and circumstances of each case. Expert witnesses often disagree about the proper method to be used.
A few of these methods are as follows:
1. Income capitalization methods:
A. Simple Capitalization - The net profit of the business is capitalized to determine the total value of the business. The value of all the tangible assets is subtracted from the total value to establish the value of the intangible assets, or goodwill.
B. Excess Earnings - the amount of earnings that are in excess of those normally earned by a similar business are capitalized to determine the value of goodwill.
C. Income Tax Method - The past five years net income is averaged and a reasonable expected rate of return for tangible assets and salary requirements are subtracted. The resulting value is then capitalized to arrive at the goodwill value.
D. Market Value - The price a willing seller would accept and a willing buyer would pay for goodwill.
E. Buy /Sell Agreement - The value of goodwill is established by a formula in the buy/ sell agreement.
F. Rule of Thumb - Goodwill is worth one years gross income.