Goodwill is the part of business value that is over and above the value of the identifiable assets owned in the company. This article I’m going to briefly explain to you How To Calculate Goodwill of a Small Business.
Simply put, Goodwill is the monetary value amount of a business based on the business reputation and name. It is often tossed around in conversation as how much your customers “like” your business.
(The picture above gives a quick view of exactly How To Calculate Goodwill of a Small Business)
When it comes to placing a value on your business, it is pretty much a P.F.T.A. number.
(Picked From Thin Air) It’s the difference between what someone is willing to pay for your company minus the value of your hard assets.
Of course, you need to start somewhere to arrive at the PFTA number, and a quick way to do it is you need to estimate the opportunity cost of the business if you started it from scratch, and built it up to the same income as the current owner has.
Let me give you a simplified example: How To Calculate Goodwill of a Small Business
Suppose you own a HVAC company.
The physical assets in the company are five vans, basic tools, a trailer, and an office with a combined value of $250,000. At the end of the year, you make $300,000.
If you sold your company for $1,000,000, the buyer would have paid $150,000 in Asset Value and $750,000 in Goodwill ($1,000,000 – $250,000). The stronger the company, the more a buyer will pay for Goodwill.
Now comes the question, why then would a buyer pay $750,000 for a name, when you can buy your own tools for $250,000 and start your own company from scratch?
The answer to this question is this: the owner of the company is making $300,000 per year.
A buyer will have immediate income and will get all of their investment money back in a little less than 3 years. If he were to start the business from scratch, it might take him or her 5 or more your to get to that point.
One way to massively increase the value of Goodwill in a business is for the owner to work their way OUT of the business and get it operating on its own.
The 20 Hour Rule Is Key
One of the biggest mistakes most business owner make is they wrongly assume that if they keep buying company assets such as machines and equipment, it will increase the value of their business. It’s a wrong assumption because tools and machinery depreciate and go down in value. It might make sense to buy tools and take a tax write-off while running the business, but you’ll never sell them for the same amount you paid for them.
Forward thinking business owners understand this and instead, focus intently on increasing Goodwill. This way, when the time comes, they can sell their business for top dollar and walk away wealthy.
In your case, focus on what creates value for customers and you will maximize the value of your business far beyond the value of your hard assets.
Find out how you score on the eight factors that drive your company’s value by completing the Value Builder questionnaire:
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