Goodwill as Measured by Customers

Goodwill is the value of a business entity not directly attributable to its assets and liabilities, i.e., a general term for all the intangibles that go into making a realistic valuation. Simply stated, Goodwill is the difference between the quantitative financial elements of a valuation and the soft, qualitative, image elements that are part and parcel of every company or brand.

Goodwill as Measured in Financial Statements

Goodwill in financial statements is an intangible asset that arises when a buyer acquires an existing business. Goodwill represents assets that are not separately identifiable.

Goodwill does not include:

• Identifiable assets that are capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability regardless of whether the entity intends to do so.

• Contractual or other legal rights regardless of whether those are transferable or separable from the entity or other rights and obligations. Examples of identifiable assets that are not financial statement goodwill include a company’s brand name, customer relationships, artistic intangible assets, and any patents or proprietary technology.

The goodwill is the excess of the “purchase consideration” (the money paid to purchase the asset or business) over the total value of the assets and liabilities. It is classified as an intangible asset on the balance sheet, since it can neither be seen nor touched. Under US GAAP and IFRS, goodwill is never amortized. Instead, management is responsible for valuing goodwill every year and to determine if an impairment is required. If the fair market value goes below historical cost (what goodwill was purchased for), an impairment must be recorded to bring it down to its fair market value. Private companies may elect to amortize goodwill over a period of ten years or less under an accounting alternative from the Private Company Council of the FASB.

Goodwill in Valuations

While an increase in the fair market value would not be accounted for in the financial statements, such assets as a company’s brand name, customer relationships, artistic intangible assets, and any patents or proprietary technology are included in the Recast Balance Sheet in a Valuation +, regardless of whether or not they appear on historical financial statements.

Goodwill impairment is financial statement goodwill that has become or is considered to be of lower value than at the time or purchase. From a financial statement perspective, when the carrying value of the goodwill exceeds the fair value, then it is considered to be impaired. Negative publicity about a firm can create goodwill impairment, as can the reduction of brand-name recognition.

Mitigation of Goodwill Impairment

Goodwill can be validated and improved by any number of existing business factors, such as:
• Assessing how many and how often past customers might continue to purchase in the future,
• The strength of the personal relationships that exist between employees of the company and its customers,
• The perceived value of company trademarks, brands, patents and other intellectual properties and whether they can be profitably extended to new products or services,
• The perceived success of company advertising and promotion efforts in keeping current customers loyal and increasing their spending, and
• The cost effectiveness of marketing programs in attracting and keeping new customers.
Traditionally, when attributing goodwill to a valuation, it is incumbent on the valuation expert to make a skillful and persuasive case for why these intangibles should result in an increased valuation. Or a valuation that is beyond purely the finances and assets of the business.

Unfortunately, though, many valuation experts fail to realize that there are many instances where it’s possible to take much of the guesswork out of generating or validating a goodwill number. And, in doing so, generate a valuation that could be quite different had they employed a more sophisticated approach.

Have a question about Business Valuations? Contact Michael Gilburd.