Advertisement

Goodwill

Goodwill is an intangible asset, which means it can be found on a company’s balance sheet in its annual accounts.

Updated September 2019

Goodwill is an intangible asset, which means it can be found on a company's balance sheet in its annual accounts. It is generated as the result of an acquisition. When one company buys another, it will typically pay a premium to the "fair value" (which is essentially an adjusted version of book value the value of a company's assets minus its liabilities). Goodwill is the difference between the acquired company's fair value and the actual price paid.

Advertisement - Article continues below

Say Company A buys Company B for £10m. The fair value of Company B's assets is £8m. The "excess" £2m paid is then listed in Company A's balance sheet as "goodwill". What does this difference represent? The value of certain intangible assets such as patents or intellectual property can be estimated, and potentially sold separately to the rest of the business.

However, other "soft" assets, such as a strong brand, a highly trained workforce, a solid record of research and development, or a loyal customer base, for example, are much harder to value. They certainly have value, but they arise from the business as a whole being more than the sum of its parts. Goodwill effectively represents the value of these assets to Company A. You could almost argue that goodwill is the value that Company A places on Company B's competitive "moat", or on its potential future growth.

Unlike most other assets, the value of goodwill does not have to be written down (amortised) every year. Instead, accounting rules state that the value of goodwill must be reviewed each year, and "impaired" (ie, written down) if necessary. Writedowns are deducted from a company's profit-and-loss account, although they don't affect cash flow.

If a company pays less than the fair value for an acquisition perhaps as the result of a distressed sale then it has negative goodwill. This happens rarely, as it implies that the acquirer has bagged a bargain.

Watch Tim Bennett's video tutorial: What is goodwill?

Advertisement
Advertisement

Recommended

Visit/glossary/601570/real-exchange-rate
Glossary

Real exchange rate

The real exchange rate between two currencies combines the nominal exchange rate with the ratio of the price of goods or services in two different cou…
26 Jun 2020
Visit/glossary/esg-investing
Glossary

ESG investing

ESG stands for environmental, social and corporate governance, the areas in which good behaviour is particularly sought.
19 Jun 2020
Visit/glossary/601496/faang-stocks
Glossary

FAANG stocks

The acronym FAANG refers to Facebook, Amazon, Apple, Netflix and Google (Alphabet) – five American companies that have been among the top-performing s…
12 Jun 2020
Visit/glossary/technical-analysis
Glossary

Technical analysis

Technical analysts or 'chartists' attempt to predict future share price (or index) movements by looking at past movements.
5 Jun 2020

Most Popular

Visit/economy/inflation/601584/the-end-of-the-bond-bull-market-and-the-return-of-inflation
Inflation

The end of the bond bull market and the return of inflation

Central bank stimulus, surging post-lockdown demand and the end of the 40-year bond bull market. It all points to inflation, says John Stepek. Here’s …
30 Jun 2020
Visit/investments/commodities/gold/601587/bullish-gold-price-cup-and-handle-chart-pattern
Gold

This chart pattern could be extraordinarily bullish for gold

The mother of all patterns is developing in the gold charts, says Dominic Frisby. And if everything plays out well, gold could hit a price that invest…
1 Jul 2020
Visit/economy/global-economy/601579/how-pent-up-demand-could-drive-a-v-shaped-economic-recovery
Global Economy

How “pent-up demand” could drive a V-shaped economic recovery

“Pent-up demand” is usually a myth. But not this time. The Covid lockdown has created genuine pent-up demand, says Merryn Somerset Webb. That’s now be…
29 Jun 2020