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This article was first published in the September 2011 edition of Accounting and Business magazine.
The valuation of goodwill assumed even greater importance with the advent of the corporate intangible fixed assets regime from 1 April 2002, which in many cases enables a newly incorporated business to claim a tax deduction on the amortisation of goodwill.
What is goodwill?
The definition of goodwill has been addressed by the courts over a considerable period of time. As early as 1810, the courts defined goodwill as 'nothing but the probability that the old customers will resort to the old place'.
In the case of Re Commissioners of the Inland Revenue v Muller & Co Margarine (1901), Lord MacNaughten spoke of goodwill as follows: 'what is goodwill? It is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of the business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business from a new business at its first start'
Goodwill has also been defined as the ability to earn 'super profits', ie profits above the usual return on the money invested in the business.
The practice of valuating goodwill is probably best described as part art, part science and goodwill valuations, although often presented as a precise calculation, will be down to what a willing buyer is prepared to pay and a willing seller is prepared to accept.
However, a number of different approaches have developed in calculating the value of goodwill:
- Whole company approach
- Simple multiple approach
- Turnover approach
- Discounted cashflow approach
Let us look at each of the above approaches in turn.