The Importance of Goodwill

Goodwill, simply stated, is the difference that exists between a business’s tangible assets and the purchase price.  Goodwill can also be looked at as encapsulating all the hard work that the seller has put into the business while building it.  That stated some do confuse goodwill value with the going-concern value, and this should clearly be avoided.  The going-concern value deals with the concept that the business will continue to operate instead of being liquidated.  Going-concern value is built around the idea that the business has ongoing value and is not ready for liquidation.

What is Goodwill? 

The M&A Dictionary deems goodwill as an intangible and fixed asset, one that can be carried on “as an asset on the balance sheet, such as a recognizable company or product name or strong reputation.  When one company pays more than the net book value for another, the former is typically paying for goodwill.” 

In other words, goodwill is not one-dimensional in nature, but instead, encompasses a range of worth that includes such variables as reputation and long-term relationships.  This often denotes a deeper value and indicates potential hidden strength within the business.  For example, a strong reputation and a plethora of long-term clients and business relationships can imbue a business with both enhanced stability and longevity.

Some Prime Examples

Determining goodwill can be a complex process as it is necessary to include an array of diverse factors.  Factors used in determining goodwill can range from having a loyal customer base and a strong reputation to the overall health of the local economy, being in a recession-resistant industry and having a good location.  Other key factors such as strong management, skilled employees and low employee turnover are further examples of goodwill. 

Other examples of goodwill can be a little more concrete in nature.  A business with technologically advanced equipment, a custom-built factory, royalty agreements, and effective advertising campaigns can also have high levels of goodwill.  Copyrights, patents, trade secrets, proprietary designs, and name recognition can all be powerful company assets that can be entered into the overall equation.

Changing Rules Regarding Goodwill

In the past, many companies were built largely around hard assets such as machinery.  But today’s industry titans are increasingly built around intellectual property, an array of patents and trademarks and even brand names.  Accountants have had to adjust to this new reality when determining value. 

New rules and standards were created by the Federal Accounting Standards Board (FASB) in 2001.  Under these new rules and standards, goodwill may not be written off.  Now, both public and private companies must include their intangible assets and this, not surprisingly, includes goodwill.  Importantly, goodwill must be valued by an outside expert.

Ultimately, goodwill is more complicated today than in the past.  Working with an experienced business broker is an excellent way to demystify the goodwill process and help to determine the true value of any business.

Copyright: Business Brokerage Press, Inc.