In the context of business valuation, this is more commonly referred to as excess earnings. Do not confuse it with the notion of business people making more than they should. Excess earnings is a technical term and it plays a central role when valuing a business under the asset approach.
This valuation method is formally known as the capitalized excess earnings technique. The idea behind the method is that superior business performance goes hand in hand with above average profitability. Established companies that excel at their game tend to command the loyalty of customers who are less price sensitive than the comparison shoppers ready to jump on the best deal from anyone.
Superior earnings indicate business goodwill
Higher earnings also underlie the concept of business goodwill. The idea is that business value is higher than the sum total of its assets. In a highly profitable company, the total business value is above the sum of its parts. This difference is business goodwill.
Measuring business goodwill is where the excess earnings come in. Business owners are viewed as investors who supply the capital needed to operate the company. As investors, they would expect a fair rate of return on this committed capital.
Top performing companies possess lots of goodwill
But highly successful companies do one better. In addition to providing their investors with a fair return on their money, these great businesses throw off additional earnings. To measure business goodwill, you would capitalize these excess earnings by the company’s capitalization rate.
Goodwill is part of total business value
The total business value then is the sum of the company’s key operating asset values plus business goodwill. The beauty of the capitalized excess earnings valuation method is the ability to translate exceptional performance into business value as the sum of invested capital assets and the intangible business goodwill.
Here is to the business owners with vision and dedication to create highly successful companies. They don’t rake in excess income, they produce excess earnings and a lot of valuable business goodwill.