Accountancy · Ch 4 — Goodwill in Partnership Accounts
Factors Affecting the Value of Goodwill
Factors Affecting the Value of Goodwill
Because goodwill is essentially a firm's capacity to earn super profits, anything that strengthens or weakens that capacity changes the value of its goodwill. There is no single formula that decides how large or small these influences are — they are qualitative factors that a valuer weighs before applying one of the quantitative valuation methods (covered later in this chapter). The most commonly examined factors are set out below.
| Factor | How it affects goodwill |
|---|---|
| Favourable location | A shop or factory in a busy, accessible, or strategically important location attracts more customers and lowers transport/logistics cost, raising goodwill. |
| Quality of products/services | Firms known for consistent quality build customer loyalty and repeat business, which increases goodwill; poor or inconsistent quality lowers it. |
| Efficient management | Skilled, experienced management runs the business more profitably and adapts faster to change, which raises the firm's earning capacity and hence its goodwill. |
| Market reputation | A firm with a trusted brand name and good standing with customers, suppliers, and lenders can command better terms and higher sales, raising goodwill. |
| Nature of business | A business dealing in essential goods with steady, high-margin demand (or holding a near-monopoly) generally commands higher goodwill than one in a highly competitive, low-margin trade. |
| Risk involved | A business with stable, predictable earnings has higher goodwill than one exposed to high risk or volatile earnings, because investors and buyers discount uncertain profits. |
| Capital required | A business that earns high profits with comparatively little capital invested is considered more efficient, and this efficiency is reflected in a higher goodwill. |
| Trend of past profits | A firm whose profits have been steadily rising over the years is valued higher than one with static or falling profits, because a rising trend suggests the higher earnings will continue. |
The overall direction — rising, falling, or fluctuating without a clear pattern — shown by a firm's profits over a run of past years; a rising trend generally justifie …
The degree of uncertainty attached to a firm's future earnings; a business with stable, low-risk earnings commands a higher goodwill than one with the same average profit bu …