CBSE Class 12-commerce Answered

The reason for this can be well understood from the fact that starting a new business initially requires a lot of hard work and even many losses in the initial years to bring business at par with competitors. Not only this, there are many preliminary expenses incurred. However, when someone purchases the goodwill of an established firm, he is going to take away all the benefits of the hardwork done by the seller. For this, buyer is required to pay off an amount equal to a few years of the future profits he would be getting because of the existing reputation of the business in form of compensation. The number of year’s purchase here indicate the time required by the new business to come at a level equal to an old settled business.