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What is Goodwill?

Goodwill is an intangible asset which helps reflect the real value of a business. A business is a lot more than a collection of physical assets with some liabilities hanging over it. Goodwill can therefore be defined as the difference between the true value of a business and the net asset value. Think of It as an estimated advantage the business has due to having a good reputation with customers and trade associates. In many cases goodwill can be of substantial value. When it is considered material it is important to include this item as an intangible asset in the financial statements.

Sources of goodwill

Example of goodwill

A business has recently compiled its financial statements and the net assets of the business excluding goodwill come to £500,000. A buyer becomes interested in the business and after assessing the business’s reputation offers the sum of £550,000. The extra £50,000 is the buyer’s payment for goodwill. However, the current business owner has worked extremely hard for many years to gain such a good reputation, and he has estimated customer and trade relations to be worth £80,000. After the owner puts forward this new figure the buyer yields and agrees to pay £580,000. The new owner capitalises goodwill in the financial statements which results in net assets inclusive of goodwill summing £580,000.

Goodwill is not always positive!

So far we have assumed a company is doing well and has a good reputation. However, this is not always the case. If a business is for sale which has a damaged reputation, say due to poor customer support, steps will have to be taken in order to repair this reputation. Suitable steps might include a new marketing campaign, recruitment of skilled telephone operators and retraining of existing staff. This all costs money which the new owner will have to spend in order to ensure the business thrives.

What happens when goodwill is negative?

Let us look again at the previous example, however, instead of the original owner estimating goodwill as being £80,000 it is instead estimated at being -£80,000. Before considering goodwill the net assets of the business again come to £500,000. Instead of goodwill being an asset, it is now considered to be a liability. Therefore, as soon as the estimate of goodwill is recognised in the liability section of the financial statements net assets will equal £420,000. This new net figure is a true and fair reflection of the worth of the business at that moment in time.

A starting point for the complexities surrounding goodwill

This article is a brief introduction to goodwill. A lot of information has been omitted and will be included in more dedicated articles as the subject of goodwill is quite in-depth. The depreciation of goodwill – amortisation as it is called, along with how goodwill is estimated and recorded in the books will be dealt with in later articles.

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