Super profit method is one of the methods, among the various methods used for valuation of goodwill of a firm or a business.
Goodwill is regarded as an intangible asset that is representative of the non-physical items which play an important role in increasing a company’s valuation in the market. It is usually taken into consideration at the time of mergers and acquisitions.
The amount paid to a company by the acquiring company over and above the market value of the company is known as goodwill.
Super Profit Meaning
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).
Steps to calculate Goodwill using Super Profit Method
The following steps are involved in the calculation of goodwill using super profit method.
1. Calculate the total capital of the business. It will be the sum total of all the net current and fixed assets along with the shareholders equity.
2. Determine the normal profit by multiplying the total capital employed with the normal rate of return.
3. Calculate the average estimated profit or average manageable profit
4. Calculate super profit by subtracting the value of normal profit from the average estimated profit to determine the super profit.
5. Multiply the super profit by the number of years of purchase to determine the goodwill.
It can be expressed in formula as follows:
Normal Profit = Capital Employed x (Normal Rate of Return/100)
Super Profit = Average estimated profit – Normal Profit
Goodwill = Super Profit x No. of years of purchase
Example of Super Profit Method
The super profit method can be explained with the help of the following question.
ABC Ltd has employed Rs.1000000 as the capital and the investors are not very happy when the income obtained from the investment is 30% while the actual profit obtained is Rs. 4,00,000.
In this question, the normal profit is 30% of 1000000 which is 3,00,000 and the actual profit is 4,00,000.
Therefore, the super profit is
Super Profit = Average estimated profit – Normal Profit
= 4,00,000 – 3,00,000
= 1,00,000
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