State any two methods of valuing goodwill.
Years’ Purchase of Average Profit Method:
Under this method, average profit of the last few years is multiplied by one or more number of years in order to ascertain the value of goodwill of the firm. How many years’ profit should be taken for calculating average and the said average should be multiplied by how many number of years — both depend on the opinions of the parties concerned. The average profit which is multiplied by the number of years for ascertaining the value of goodwill is known as Years Purchase. It is also called Purchase of Past Profit Method or Average Profit Basis Method.
Years’ Purchase of Weighted Average Method:
This method is the modified version of Years’ Purchase of Average Profit Method. Under this method, each and every year’s profit should be multiplied by the respective number of weights, e.g. 1, 2, 3 etc., in order to find out the value of product which is again to be divided by the total number of weights for ascertaining the weighted average profit. Therefore, the weighted average profit is multiplied by the years’ purchase in order to ascertain the value of goodwill. This method is particularly applicable where the trend of profit is rising.