What is meant by Capitalisation of Average Profit?

Capitalisation of Average Profit is also known as Capitalised value of the business.

It is determined by capitalising the average profit earned at the normal rate of profit.

For example, the average profit is ₹ 25,000 and the normal rate of return is 10%.

The Capitalisation of the average profit means the capital that is to be needed to earn average profit at a normal rate of return.

Hence, Capitalised Value of Average Profit = Average Profit × 100/Normal Rate of Return (Profit)

Capitalised Value of Average Profit = 25000 × 100/10 = ₹ 25,000

It is one of the methods of calculating the goodwill of the firm.

Where goodwill of the firm is calculated by deducting Capital employed from Capitalised Value of Average Profit

Thus formula is

Goodwill of the firm = Capitalised Value of Average Profit – Capital Employed