How to Calculate Goodwill: Formulas, Examples, & More (2025)

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1Calculating Goodwill Using Average Profits

2Calculating Goodwill Using Super Profits

3Calculating Goodwill Using Capitalization of Profits

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Co-authored byDarron Kendrick, CPA, MA

Last Updated: January 5, 2024Approved

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Goodwill is a type of intangible asset — that is to say, an asset that is non-physical, and is often difficult to value. Along with goodwill, these types of assets can include intellectual property, brand names, location and a host of other factors. Goodwill refers to a premium over the fair market value of a company that a purchaser pays, and this premium can often be attributed to intangible items like reputation, future growth, brand recognition, or human capital. It is the portion of a business's value that cannot be attributed to other business assets. The methods of calculating goodwill can all be used to justify the market value of a business that is greater than the accounting value on a company's books. While there are many different ways to calculate goodwill, income-based methods are the most common. Keep in mind that goodwill exists only when a buyer pays more for an asset than the asset is worth, not before.

Method 1

Method 1 of 3:

Calculating Goodwill Using Average Profits

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  1. 1

    Understand how the average profits method is applied. Under this method, Goodwill is equal to the average profits for a set time period, multiplied by the number of years. This is the simplest and the most common method to calculate goodwill.

    • To summarize the formula: Goodwill = Average Profits X Number of Years.
    • For example, if you used the average annual profits of the years 2010-14, you would multiply the average by 5.
  2. 2

    Adjust the numbers before you make the calculations. Make sure that you make the following adjustments before computing average profits:[1]

    • Any abnormal profits should be deducted from the net profits in the year that they were earned.
    • Any abnormal losses should be added back to the net profits in the year they were incurred.
    • Non-operating incomes (e.g., income from investments) should be deducted from the net profits of the year that they were earned.

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  3. 3

    Do the math. Start by determining the average profits for the years under consideration. To find average profits, you add together the profits of all the years and divide by 4 (the number of years).

  4. 4

    Let's say there was a company that had these profits (in the associated years): 2010: $200,000; 2011: $220,000; 2012: $190,000; 2013: $210,000. You would first add these numbers together to get $820,000.

    • Divide the sum ($820,000) by the number of years, which in this case is four. The result is the average. In this case, the average profits equals $205,000.
    • As Goodwill is equal to the average profit over a given span of years multiplied by the number of years, Goodwill would equal $820,000. In this case, Goodwill was really just the aggregated total of profits from the given years. In the real world, abnormal costs and profits would have altered the result.
  5. 5

    Add the Goodwill to the fair market value of the business. If making a purchase offer for a business, this Goodwill amount could be added to the fair market value of the business, or its assets minus its liabilities. In this case, Goodwill is a premium over the fair market value of the business that reflects the average profits the business earns over several years.

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Method 2

Method 2 of 3:

Calculating Goodwill Using Super Profits

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  1. 1

    Establish your average profits. For this method, you will need to understand what your average profits from previous years are. Add together the profits of previous years, and divide by the total number of years.

    • For example, you may have earned $200,000 in 2010, $220,000 in 2011, $190,000 in 2012, and $210,000 in 2013. Add these all up to get $820,000 and divide by four years. You will get $205,000, which is the average profit.
  2. 2

    Subtract your average profits from your actual profits. Super profits are the profits earned above the average profits. To learn what your super profits are, take this year's actual profits and subtract your average profits from them. For example, let's say the average profit for your business is $200,000. In one year you earned a net profit of $230,000. The excess of profits earned over the average profits — the super profit — is $30,000.

  3. 3

    Learn the super profits formula for goodwill. For calculating goodwill, the total super profits of a given number of years are multiplied by the agreed number of years of purchase. Put another way — Goodwill = Super Profits X Number of Years.”[2]

  4. 4

    See how the model is applied. An example is provided to demonstrate how the super profits formula is applied.

    • Let's say average profits had been $200,000, but the actual actual profits in a four year span were: 2010: $210,000; 2011: $230,000; 2012: $210,000; 2013: $200,000.
    • The super profits for each year are calculated by subtracting the average profit from the actual profit. For 2010, the super profit is 10,000; for 2011 it is 30,000, etc.
    • The yearly super profits are then added together. For this example, you end up with $10,000 + $30,000 + $10,000 + 0 = $50,000.
    • Finally, the total super profit is multiplied by the number of years. In this case, Goodwill = $50,000 X 4 or $200,000.
  5. 5

    Add the Goodwill to the fair market value of the business. In this case, Goodwill would be reflective of a company/s ability to earn more than its average profits. By adding the super profits to the fair market value of the business, your purchase price reflects a company's earnings power.

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Method 3

Method 3 of 3:

Calculating Goodwill Using Capitalization of Profits

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  1. 1

    Understand the capitalization method. This method starts with the results of one of the other two methods. Beginning with average or super profits, the capitalization method determines how much capital is needed to produce those average or super profits, assuming the business earns a normal rate of return for the particular industry. This amount of capital is known as the capitalized value of profits, and the excess of this figure over the total capital employed can be considered goodwill.

  2. 2

    Calculate total capital employed. To find the capital employed, simply subtract the liabilities from the assets. It can also be represented as: Capital Employed = Assets - Liabilities.

  3. 3

    Learn how to calculate capitalized value of profits. In order to use the the capitalization method, you must know how to calculate the capitalized value of profits.

    • In order to find the capitalized value of profits, you must first multiply the average or super profit by 100 (either one works). The total must then be divided by the normal rate of return. The formula can also be represented as: Capitalized Value of Average/Super Profits = Average/Super Profits X (100 / Normal Rate of Return). This formula calculates how much capital is required to earn the average or super profits of the business, assuming it made a normal rate of return.
  4. 4

    Calculate goodwill. Simply subtract capital employed from step 2, from capitalized value of average or super profits. The formula looks like this: Goodwill = Capitalized Value of Average/Super Profits - Capital Employed.

    • Consider an example. Let's say that firm has average profits of $40,000, in an industry where the normal rate of return is 10%. The firm also has $1,000,000 in assets and $500,000 in liabilities. The total capitalized value of the firm is $40,000 × 100/10, which is equal to $400,000. The capital employed = $1,000,000 − $700,000, which leaves $300,000. Finally, goodwill is equal to capitalized value of profits minus the capital employed, or $400,000 − $300,000. The goodwill is $100,000.
    • With this method, goodwill is reflective of the difference between the rate of return of the business in question, and the normal rate of return. For example, in this scenario, the business would earn a 13% return on capital employed ($40,000/$300,000). The normal return, however, is 10%. This method simply takes that 3% premium, and "capitalizes" it, or determines how much capital employed would be required to produce that $40,000 return based on a 10% normal return. In this case, it would require $400,000, or $100,000 more than the actual fair value of the businesses assets. This $100,000 could be added to the fair value of the business when selling or purchasing it, as a reflection of the company's strong returns.
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  • Question

    For a new small business, with a loss for the first year, would there be a value for the goodwill then, and how is this calculated?

    Darron Kendrick, CPA, MA
    Financial Advisor

    Darron Kendrick is an Adjunct Professor of Accounting and Law at the University of North Georgia. He received his Masters degree in tax law from the Thomas Jefferson School of Law in 2012, and his CPA from the Alabama State Board of Public Accountancy in 1984.

    Darron Kendrick, CPA, MA

    Financial Advisor

    Expert Answer

    Unless a new business with an initial year loss is in a hot market, such as technology, or has some type of market edge or celebrity appeal, there would be little chance of finding goodwill.

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  • Question

    How then does a startup calculate goodwill as a way of knowing the value of the startup?

    Michael R. Lewis
    Business Advisor

    Michael R. Lewis is a retired corporate executive, entrepreneur, and investment advisor in Texas. He has over 40 years of experience in business and finance, including as a Vice President for Blue Cross Blue Shield of Texas. He has a BBA in Industrial Management from the University of Texas at Austin.

    Michael R. Lewis

    Business Advisor

    Expert Answer

    There is no goodwill in a start-up balance sheet, since there was no cost to acquire the intangible asset. Goodwill exists *only* when a buyer pays more for an asset than the asset is worth, not before.

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  • Question

    If the accounts of the firm are not real, than what has to done to arrive at Goodwill?

    Darron Kendrick, CPA, MA
    Financial Advisor

    Darron Kendrick is an Adjunct Professor of Accounting and Law at the University of North Georgia. He received his Masters degree in tax law from the Thomas Jefferson School of Law in 2012, and his CPA from the Alabama State Board of Public Accountancy in 1984.

    Darron Kendrick, CPA, MA

    Financial Advisor

    Expert Answer

    There would be no goodwill in a situation based upon fraudulent information. At least not after the fraud was discovered.

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      • All the above methods are considered useful, and often a method that provides the most favorable purchase price will be selected.

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      • This article is for information purposes only. Contact a certified public accountant or attorney to check over any goodwill calculation you have completed or if you unsure on the best way to value a business's goodwill.

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      • Other methods of calculating goodwill include market-based and cost-based methods, although these are not as common.

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      About This Article

      How to Calculate Goodwill: Formulas, Examples, & More (29)

      Co-authored by:

      Darron Kendrick, CPA, MA

      Financial Advisor

      This article was co-authored by Darron Kendrick, CPA, MA. Darron Kendrick is an Adjunct Professor of Accounting and Law at the University of North Georgia. He received his Masters degree in tax law from the Thomas Jefferson School of Law in 2012, and his CPA from the Alabama State Board of Public Accountancy in 1984. This article has been viewed 423,764 times.

      10 votes - 70%

      Co-authors: 16

      Updated: January 5, 2024

      Views:423,764

      Categories: Buying a Business

      Article SummaryX

      The simplest and most common way to calculate Goodwill is to use the formula Goodwill = Average Profits × Number of Years. Before you do the calculation, be sure to make any necessary adjustments, like adding abnormal losses back to or deducting abnormal profits from net profits in the relevant years. When you’ve made your adjustments, get Average Profits by adding together the profits from all the years and dividing by the number of years. You can then just multiply that result by the Number of Years to get your value for Goodwill. For information from our Accountant reviewer on calculating Goodwill by using the capitalization of profits, read on!

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      How to Calculate Goodwill: Formulas, Examples, & More (2025)

      FAQs

      How to Calculate Goodwill: Formulas, Examples, & More? ›

      The goodwill calculation method is represented as, Goodwill Formula = Consideration paid + Fair value of non-controlling interests

      non-controlling interests
      In accounting, minority interest (or non-controlling interest) is the portion of a subsidiary corporation's stock that is not owned by the parent corporation.
      https://en.wikipedia.org › wiki › Minority_interest
      + Fair value of equity previous interests - Fair value of net assets recognized.

      How do you calculate goodwill examples? ›

      If Company B purchases Company A for $250,000, the amount of economic goodwill “created” would be the purchase price minus the fair market value of net assets: $250,000 – $209,000 = $41,000.

      What is the correct formula for goodwill? ›

      One of the simplest methods of calculating goodwill for a small business is by subtracting the fair market value of its net identifiable assets from the price paid for the acquired business. Goodwill is an intangible asset that arises when a business is acquired by another.

      Which is the best method to calculate goodwill? ›

      Simple Average – In this process, goodwill evaluation is done by calculating the average profit by the number of years it is called years purchase. It can be calculated by using the formula. Goodwill = Average Profit x No. of years' of purchase.

      How do you calculate goodwill for 5 years? ›

      2. Super Profits Method
      1. Goodwill = Super Profit x No. of years' of purchase.
      2. # Super Profit = Actual or Average profit – Normal Profit.
      3. # Normal Profit = Capital Employed x (Normal Rate of Return/100)

      What is a simple example of goodwill? ›

      Goodwill Example

      To put it in a simple term, a Company named ABC's assets minus liabilities is ₹10 crores, and another company purchases the company ABC for ₹15 crores, the premium value following the acquisition is ₹5 crores. This ₹5 crores will be included on the acquirer's balance sheet as goodwill.

      What are the three types of goodwill? ›

      There are two distinct types of goodwill, namely the purchased goodwill and inherent goodwill. There are three methods used for the valuation of goodwill: Super Profits, Average Profits, and Capitalization Method.

      Why is goodwill hard to calculate? ›

      Although goodwill is the premium paid over the fair value of an entity during a transaction, goodwill's value cannot be sold or bought as an intangible asset in of itself. Goodwill can be challenging to determine its price because it is composed of subjective values.

      What is the formula for goodwill in Excel? ›

      The goodwill calculation method is represented as, Goodwill Formula = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests - Fair value of net assets recognized.

      What is the full goodwill method? ›

      This method can be referred to as the gross or full goodwill method. It determines the goodwill that relates to the whole of the subsidiary, ie goodwill that is both attributable to the parent's interest and the non-controlling interest (NCI).

      What is the formula for goodwill to assets? ›

      The goodwill to assets ratio is calculated by dividing goodwill, which is usually found in the no-current assets section of a company's balance sheet, by total assets.

      What is the formula for normal profit in goodwill? ›

      Goodwill is calculated under super profits method by multiplying the no. of years purchased with super profits. The excess of actual profits over the normal profits is termed as super profits, Normal Profit = Capital Employed X Normal Rate of Return/100.

      How do I write off goodwill? ›

      The goodwill account is debited with the proportionate amount and credited only to the retired/deceased partner's capital account. Thereafter, in the gaining ratio, the remaining partner's capital accounts are debited and the goodwill account is credited to write it off.

      What is the basic calculation of goodwill? ›

      It's calculated by taking the purchase price of a company and subtracting the difference between the fair market value of the assets and liabilities. Companies are required to review the value of goodwill on their financial statements at least once a year and record any impairments. Goodwill has an indefinite life.

      How to find hidden goodwill? ›

      Difference between the capitalized value of the firm and the net worth of the firm is treated as the value of Hidden Goodwill. In other words, we can say hidden Goodwill is the Inferred Goodwill. This is not given in question but is implied from brought in capital by the new partner for his share in the firm.

      What is the super profit method of goodwill? ›

      Super profit is the excess of estimated future profit than the normal profit. It is a way of determining the extra profits that are earned by the business. The goodwill is determined by multiplying the value of super profits by a certain number (that number being the number of years of purchase).

      What is the formula for full goodwill? ›

      The goodwill calculation method is represented as, Goodwill Formula = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests - Fair value of net assets recognized.

      What is an example of goodwill on a balance sheet? ›

      For example, if Company A acquires Company B for $500,000 and the fair market value of Company B's net identifiable assets is $400,000, the goodwill would be calculated as $500,000 - $400,000 = $100,000. This $100,000 would then be recorded as an intangible asset (goodwill) on Company A's balance sheet.

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