Valuation methods based on goodwill

economic-dictionary

Valuation methods based on goodwill are company valuation methods that use the value of goodwill as a reference to value a company.

These types of methods are considered mixed, since they perform a part of the assessment statically and another dynamically. The static part has to do with the current assets of the company. For its part, the dynamic part tries to quantify the value that the company will generate in the future.

Types of valuation methods based on goodwill

There are, broadly speaking, seven types of valuation methods based on goodwill. They all agree that the value of the company is equal to the value of the net assets (A), plus the value of the goodwill. Depending on the method, goodwill will be calculated in one way or another:

  • Classic valuation method

This method distinguishes between large or industrial companies and retail.

For industrial companies the formula is:

V = A + (n x B)

  • V = Value of the company
  • A = Net assets
  • c = Arbitrary coefficient that expresses the estimated growth of profits. It is between 1.5 and 3
  • B = Net profit

For small businesses the formula is:

V = A + (z x F)

  • V = Value of the company
  • A = Net assets
  • z = Percentage of the company's sales figure
  • F = Company turnover
  • Simplified method of abbreviated income from goodwill.

This method is also known as the simplified Union of Accountants (UEC) method. It is calculated by capitalizing the company's super profit at compound interest. This super profit is nothing more than the previous year's profit minus the money made by investing capital equal to the value of the company at a risk-free rate.

V = [A + (an x B)] / (1 + ian)

  • V = Value of the company
  • A = Net assets
  • an = updated value of the company at n periods
  • B = Company profit
  • ian = return on investment without risk of the company's updated value at n periods
  • Indirect method

Updates the value of the benefits at the rate of the yield of the government bonds. Sometimes the value of the benefits (B) is calculated as an average of the previous years.

V = (A + B / i) / 2

  • V = Value of the company
  • A = Net assets
  • B = Company profit
  • i = Return on long-term government bonds
  • Direct method

This method differs from the previous one in the interest rate to be applied ™ and in that it updates the difference between profit (B) and net assets (iA) and not just profit.

V = A + (B - iA) / tm

  • V = Value of the company
  • A = Net assets
  • B = Company profit
  • iA = Updated net assets
  • tm = long-term state fixed income interest rate multiplied by a coefficient between 1.25 and 1.5.
  • Annual results purchase methods

It is a variation of the previous methods. Eliminate the discount coefficient (tm or 2) and add a projection in years (m).

V = A + m x (B - iA)

  • V = Value of the company
  • A = Net assets
  • B = Company profit
  • iA = Updated net assets
  • m = Number of years that the difference between profit (B) and updated net assets (iA) is projected
  • Risk rate and risk-free rate method

It has the same objective as the abbreviated income method but includes a rate with risk (t) and another without risk (i).

V = (A + B / t) / (1 + i / t)

  • V = Value of the company
  • A = Net assets
  • B = Company profit
  • t = Interest rate with risk
  • i = Interest rate without risk

Criticisms of valuation methods based on goodwill

Some authors indicate that goodwill represents the value of the intangible elements of the company. In most cases this is not reflected in the balance, but in an effort to balance it, it is subjectively adjusted.

Hence, the methods based on goodwill are pointed out by some experts as arbitrary. That is, they are not reliable scientific methods. They are based more on guesswork and subjective appraisals than on reality.

We must remember that goodwill represents elements such as: client portfolio, brand image, strategic alliances, reputation, etc. See goodwill

Finally, we must emphasize that these methods are not widely used today. They continue to be studied, as they help us understand how companies are analyzed before. In any case, each analyst is free to analyze and value a company according to the method he considers appropriate.

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