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/bonds
Glossary

Bonds

A bond is a type of IOU issued by a government, local authority or company to raise money.
19 May 2020
Visit/spending-it/glossary/601300/quantitative-investing
Glossary

Quantitative investing

Quantitative investing uses sophisticated computer-based mathematical models to identify and carry out trades.
8 May 2020
Visit/glossary/quantitative-easing-qe
Glossary

Quantitative easing (QE)

Quantitative easing (QE) involves electronically expanding a central bank's balance sheet.
8 May 2020
Visit/glossary/600702/emerging-markets
Glossary

Emerging markets

An emerging market is an economy that is becoming wealthier and more advanced, but is not yet classed as "developed".
24 Jan 2020

Most Popular

Visit/investments/commodities/industrial-metals/601401/money-printing-infrastructure-base-metals-copper
Industrial metals

Governments’ money-printing mania bodes well for base metals

Money is being printed like there is no tomorrow. Much of it will be used to pay for infrastructure projects – and that will be good for metals, says …
27 May 2020
Visit/economy/eu-economy/601422/heres-why-investors-should-care-about-the-eus-plan-to-tackle-covid-19
EU Economy

Here’s why investors should care about the EU’s plan to tackle Covid-19

The EU's €750bn rescue package makes a break-up of the eurozone much less likely. John Stepek explains why the scheme is such a big deal, and what it …
28 May 2020
Visit/investments/funds/601385/in-support-of-active-fund-management
Funds

In support of active fund management

We’re fans of passive investing here at MoneyWeek. But active fund management has its place too, says Merryn Somerset Webb.
25 May 2020