What is the basis of the Average Profits Method for valuing goodwill?

Average profits of the past few years

The Average Profits Method for valuing goodwill is based on the average profits earned by the firm over a specified period of time, typically the past few years. This method assumes that the firm's past average profits are a reliable indicator of its future profitability. By taking the average profits and multiplying them by a predetermined number of years, the method calculates the value of goodwill. The underlying assumption is that a purchaser of a running business should pay for the anticipated profits they are likely to receive in the first few years.