Goodwill
Goodwill (reputation, overvalue) - the excess profitability of a company and the ability to generate above average profits of the business entities. This is one of the items included in the balance sheet called: intangible assets. Goodwill (the name of a company's brand) becomes a component of the value of the company, being fairly estimated surplus value operator - including the ability to generate profits in the future. Goodwill is defined as the sum or value of the non-asset, non-material items.
Goodwill may be combined with the synergy that arises within the company and, consequently, contributes to the growth of the market value of the entire enterprise.
Valuation of goodwill
In many companies, especially those with well-known, widely recognizable brand and a long tradition, the greatest value of the intangible asset is goodwill. Often its value largely deviates from the value of tangible assets of the company. Due to the fact that the goodwill lacks many features that are attributed to the definition of assets (including traceability and individuality), valuation of goodwill becomes a complex problem, and managers devote much attention to it.
There are three main approaches to the valuation of goodwill:
- The valuation of favorable attitudes toward the company.
- By the present discounted value of expected future profits of the surplus over and above those considered normal, the average total return on investment - if goodwill were not taken into account.
- The valuation of the main account - surplus value over valuation of each individual item of tangible and intangible net assets
Due to the often high value and importance of goodwill, the valuation of companies apply a differentiated approach into valuation of reputation. Among the mixed methods of valuation, which take into account both assets and income of the company, among others there can be distinguished: German method, method of UEC, annual purchase method and the others.
Issues in goodwill reporting
Highly developed countries in their accounting systems recognize the elusive, hard to measure value of goodwill. The solutions adopted by them are characterized by great diversity, which concerns the recognition of goodwill as an asset, the valuation of goodwill on consolidation of financial statements in mergers and acquisitions of companies, depreciation methods and amortization periods, the possibility or not of a single write-down of goodwill in the burden of capital reserves during acquisitions of companies.
Examples of Goodwill
- Reputation: Goodwill is often associated with a company’s reputation and can be a major factor in a customer’s decision to purchase a product or service. A company with a good reputation for quality and customer service can attract more customers and generate higher profits.
- Human Resources: Goodwill can also be associated with the value of a company’s employees. A company with experienced and skilled employees may be able to command higher prices for its products or services, as these employees are a valuable asset to the company.
- Brand Recognition: Goodwill can also refer to the value of a company’s brand recognition. Companies with strong brand recognition can often charge higher prices for their products or services, as customers are more likely to recognize and purchase a product or service from a well-known brand.
- Intellectual Property: Goodwill can also refer to the value of a company’s intellectual property. Intellectual property includes patents, copyrights, trademarks, and trade secrets. These can be valuable assets to a company, and can be used to generate income or protect the company from competition.
Advantages of Goodwill
Goodwill provides many advantages to a business, including:
- Improved customer loyalty and trust, as customers are more likely to stick to a company that has a good reputation. This can lead to increased sales and customer relationships.
- Increased brand recognition and awareness, as customers are more likely to recognize a company with a good reputation.
- Increased ability to negotiate better deals with vendors, as a good reputation often allows businesses to get better deals from suppliers.
- Increased access to capital, as investors and lenders are more likely to invest in a company with a good reputation.
- Improved employee morale, as employees are more likely to be proud to work for a company that is well-known and respected in the community.
- Increased ability to attract and retain top talent, as a good reputation can make a company more attractive to potential employees.
Limitations of Goodwill
- Goodwill is an intangible asset, and as such, can be difficult to measure and value.
- It can be affected by external factors, such as the economy or changes in the industry.
- Overvaluation of goodwill can have a negative impact on the company’s financials.
- Goodwill is a long-term asset and does not generate an immediate return on investment.
- If the conditions that created the goodwill change, the value of the asset may decline.
- It may not be transferable if the business is sold, and may need to be adjusted for the fair market value.
- Goodwill can be subject to impairment, in which case it may need to be written down or off.
- Goodwill is a non-cash asset, so it does not directly add to the company’s cash flow.
- Goodwill Impairment - This is the process of determining whether a company has a permanent impairment of its goodwill from an accounting standpoint. If the company’s net worth falls below the value of its goodwill, then the company has incurred a goodwill impairment.
- Purchased Goodwill - This is the portion of a company’s goodwill that is purchased from another company. This is typically calculated by subtracting the fair market value of the assets of a company from its purchase price.
- Generated Goodwill - This is the portion of a company’s goodwill that is generated internally through its operations, such as the development of a strong brand or customer loyalty.
In summary, Goodwill is a non-asset, non-material item that is used to represent the excess profitability of a company and the ability to generate above average profits of the business entities. Other approaches related to goodwill include impairment, purchased and generated goodwill.
| Goodwill — recommended articles |
| Market value added — Going-concern value — Money measurement concept — Economic income — Economic obsolescence — Total capital — Asset based approach — Optimal capital structure — Asset sales |
References
- Dore, R. (1983). Goodwill and the spirit of market capitalism. The British Journal of Sociology, 34(4), 459-482.
