Capitalization of average Profit Method of Valuation of Goodwill

The following steps are to be taken in ascertaining the value of goodwill under this method:

(i) Ascertain the average future maintainable profit, as explained already.

(ii) Capitalize this average profit at the normal rate of return on investment on the type Of business under consideration:

This will give the net worth of the business.

(iii) Find out the value of net tangible assets (i.e., net assets other than goodwill) of the business.

(iv) Deduct the net tangible assets from the capitalised net worth of the business and the difference is goodwill.

(i) Capitalization of Average Profits: Under this method, the value of goodwill is calculated by deducting the actual capital employed from the capitalized value of the average profits on the basis of the normal rate of return.

Goodwill = Normal Capital – Actual Capital Employed

Normal Capital or Capitalized Average profits = Average Profits x (100/Normal Rate of Return)

Actual Capital Employed = Total Assets (excluding goodwill) – Outside Liabilities

(ii) Capitalization of Super Profits: Under this method, Goodwill is calculated by capitalizing the super profits directly.

• Goodwill = Super Profits x (100/ Normal Rate of Return)