How to Establish Goodwill
How to establish the amount of goodwill: First establish the current annual nett profit, then deduct a salary for the owner/manager and allow interest (or return) on the total capital invested. Any surplus is the "super profit" or the business's "extra" earning power. Apply a multiplier (or "year's purchase") based on the certainty that these profits will continue. A lack of super profit may suggest there is no goodwill in the business.
There are a few provisos to the above. Buying a package of which price is only one component. Goodwill reflects not only monetary factors but also reputation, ease of running the business, working hours and existing lease. If demand is weak or economic conditions are unfavourable little or no goodwill can be expected.
Bear in mind that the "super profit" method is only one of several ways of calculating goodwill. With many smaller businesses including dairies and lunch bars, goodwill is based on so many weeks turnover. With smaller but well located retail businesses the "goodwill" in fact may be "site goodwill" or key money for the premises rather than a payment for the profitability of the business.
Hotels and motels are specialist businesses and have their own "formulae" for determining goodwill. Annual turnover and remaining term of the lease are very important. Provided running expenses fall within accepted percentage parameters and turnover is adequate on a per unit or per week basis, goodwill is a "mixture" of the residual after allowing for chattels, site goodwill which is virtually key money, a payment of the "intrinsic" benefits of running a motel or hotel, plus profitability.
Finally, do not expect to receive or pay goodwill on the basis of illusory undisclosed cash sales.