The very first question is, what is super profit? According to the Super Profit Method, the firm's earnings are derived from its capital. Working capital refers to the money contributed by shareholders. That is the entire amount of share capital, reserves, and excess (i.e. undistributed profits). Another definition is the sum of a company's tangible assets minus its absolute obligations to outside parties.
Defining Super Profit Method
The Super Profit Method determines a company's goodwill by looking at its profit margins relative to those of similar businesses. Super profit refers to an increase in net income above and above what would be considered usual. Consequently, under this approach, the value for goodwill is calculated by multiplying super profits by the number of years of purchases.
This technique calculates goodwill:
Goodwill = Super Profit * Purchase Years
Advantages of Using Super Profit Method
This method is beneficial because it helps:
To determine how much goodwill there is, you multiply the super profit by the agreed-upon number of years of purchase.
The business makes money from the money it spends.
It is a way to figure out how much extra money the business makes.
Steps to Calculate Goodwill by Super Profit Method
The super profit method of goodwill calculation involves the following steps:
Step 1- Determine the company's typical earnings per share.
Step 2- Determine the amount of the company's working capital.
Capital Employed equals Total Assets (excluding fictional assets) minus Liabilities to Third Parties or Outside Sources.
Put another way, capital employed equals share capital plus free reserves minus fictitious assets.
Step 3- Use the Typical Rate of Return to Determine the normal return on Capital Expended.
Step 4- Determine the Super Profit by taking the Normal Profit away from the Average Profit and then calculating the difference. The formula for calculating super profit is average profit minus expected profit.
Step 5- For calculation of super profit value, multiply its Super Profit by the Total Number of Years of Purchases.
Super Profit Method
Valuation of Goodwill by Super Profit Method
Using this super profit method of valuation of goodwill, one arrives at the computation for the super profit by first determining the normal gain and then subtracting that number from the average profit. The usual rates of return determine the standard yield; thus, the super profits are the anticipated profit that is made in addition to the typical gain. Alternatively, we may say the super profit in the calculation of goodwill by the super profit method is additional profits, which is the same as saying that they are greater than the average profit. In the stock market jargon, we might refer to this as Alpha.
The adjusted profit is the same as the average profit. If there are any costs and revenue that need to be modified, then they must be added or subtracted depending on what the need is. There won't be any goodwill in the company if there aren't any extra or super earnings on top of the regular profits. The super profit formula:
Standard Gain = Capital Utilised x (Standard Return / 100).
Profit Plus = Actual Profit - Average Profit
The formula for calculating goodwill and the technique of appraising goodwill has been covered in this chapter. Goodwill is an intangible asset that can't be seen or felt, but it can be purchased or sold, and it is correct. In other words, we might say goodwill is just an incorporeal asset. Some examples of goodwill can be found in the super profit method PDF, which includes the price of a corporate brand name, a solid customer base, good employee affiliations, functioning consumer associations, and any proprietary and patent-protected technology.