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Definition: Excess Earnings
Excess Earnings is the earnings which exceeds the fair return from the assets (tangible) and is generally derived from company’s goodwill among customers or from its reputation. Excess earnings is calculated by Excess Earnings method.
Excess Earnings method is an asset based valuation method which is used to find the value of intangible assets during business valuation which in turn depends on both tangible assets and intangible assets.
Flow Chart to calculate excess earnings and total market value of a company
Assume a XYZ company with pre-tax income of Rs. 70,000 and net tangible assets of Rs. 2,10,000. Let 10% be the rate of return on the net tangible assets and 20% be the rate on intangibles. Find out the excess earnings and value of the company.
Step 1 : Calculate earnings attributable to tangible assets
Multiply 10% rate of return of tangible assets with its market value
10%(2,10,000) = Rs. 21,000
Step 2 : Calculate earnings attributable to intangible assets
Deduct earnings attributable to net assets from company’s total earnings