FACTORS AFFECTING GOODWILL

The factors leading to goodwill are the following:

1. Special locational advantages;

2. Special commercial advantages such as a long-term contract for supply of raw materials at a low price or
for sale of finished goods at remunerative prices;

3. Advantages because of prior entry specially if later is very difficult;

4. Advantages enjoyed by it because of certain patents available to it;

5. Technical know-how possessed by the firm;

6. The research and development effort; and

7. Above all, the advantage enjoyed by the superiority of its man-power specially management; this is reflected in superior products, better exploitation of markets, new products and new markets, etc.

The first four factors are temporary in nature; the other three are permanent.

Factors having a bearing on valuation: In addition to what has already been stated, in a valuation, consideration of the following factors is also necessary:

(a) Nature of the industry, its history and the risks to which it is subject;

(b) Prospects of the industry in the future;

(c) The company’s history – its past performance and its record of past profits and dividends;

(d) The basis of valuation of assets of the company and their value;

(e) The ratio of liabilities to capital;

(f) The nature of management and the chance for its continuation;

(g) Capital structure or gearing;

(h) Size, location and reputation of the company’s products;

(i) The incidence of taxation;

(j) The number of shareholders;

(k) Yield on shares of companies engaged in the same industry, which are listed in the stock-exchanges;

(l) Composition of purchasers of the products of the company; and

(m) Size of block of shares offered for sale since for large blocks very few buyers would be available and that has a depressing effect on the valuation. Question of control, however, may become important, when large blocks of shares are involved.

To put the above in different words, the factors would be:

(i) Profitability: Profitability of a concern is the chief factor in valuation of goodwill. One who pays for goodwill looks to the future profit. The profits that are expected to be earned in future are extremely important for  valuation of goodwill. The following are the important factors that have a bearing on future profits and, therefore, the value of goodwill :

(a) Personal skill in management;

(b) Nature of business;

(c) Favourable location;

(d) Access to supplies;

(e) Patents and trade marks protection;

(f) Exceptionally favourable contracts; and

(g) Capital requirements and arrangement of capital. N.B.: A very careful estimate of the profits expected to be earned by the firm and the amount of capital employed to earn such profits, has to be made;

(ii) General reputation which the firm or the company and its management enjoys;

(iii) Yield expected by investors in the industry to which the firm or company belongs.