This explains what goodwill is and how it is applicable to property

Goodwill is an intangible asset. It cannot be seen or felt physically. However, it is not a fictitious asset. It has value, and can be sold and transferred. Sometimes, goodwill is more valuable than the tangible asset itself. A person making a sacrifice must be compensated for the loss through goodwill.

While purchasing property, especially commercial property, you have to invariably pay for the goodwill. Goodwill is easy to think of but very difficult to define. It is something which will bring to the purchaser profits in future almost without his own efforts. The efforts have already been made in the past. Goodwill is the ability to earn profits higher than others. It enables earning of excess profits over and above what generally firms earn. It arises only if the firm can earn super profits.

Goodwill is the probability that customers will patronise the old place or supplier. It enhances the capacity of the business to earn profits in the future. It is the benefit and advantage of the good name, reputation and connection of a business. It is something that distinguishes an old established business from a new business. It is the value of the reputation of a firm in respect of profits in future over and above the normal expected profits.

When a person pays for the goodwill, he pays for something which places him in the position of being able to earn more than he could have by his own unaided efforts.

The value of goodwill depends on the mutual agreement between the purchaser and the seller. There are a few accounting methods available to determine the quantum of goodwill. One of the methods is called the 'number of years' purchase of average profits'. Under this method, the past profits of a number of years are totalled up and average found out. The average profits are then multiplied by a certain number of years to arrive at the goodwill. The number of years is with reference to the future expected number of years for which the excess profits will continue.

Another method is the capitalisation method where the value of the business is ascertained on the basis of actual profits, which is capitalised at a predetermined rate. Builders charge goodwill for shops in the vicinity of residential societies as the purchaser gets access to a large consumer group. Similarly, cinema halls charge goodwill for opening eating places within the premises. Same is the case of hospitals charging goodwill for opening of chemist shops within the hospital premises.

The logic is simple. By virtue of having a chemist shop within the hospital premise, the chemist gets an assured supply of customers. The hospital needs to be compensated for the benefit being availed of the chemist by virtue of the location in the hospital premises.

Being an intangible asset, the rules of valuation differ from business to business and place to place.

Some factors that influence determination of goodwill:

• Location

If the business is located at a potential place, resulting in good sales or economies, the value of goodwill will be correspondingly higher. For example, a property in the central business district will command a higher goodwill than one in the outskirts.

• Significant factors

In some cases, if a place has historic significance, its goodwill will also be correspondingly higher. The people who live in the surrounding areas can increase the goodwill. Presence of large companies in the vicinity enhances the value of the property.

• Conveniences

Factors such as access to supplies make a difference. Also, if a firm enjoys a good reputation for the quality of its products, the value of its goodwill will be high.