Accounting Goodwill or Goodwill Accounting

Means something different from the everyday goodwill definition!

Accounting goodwill represents the value or amount paid in stock or cash for an acquisition above the identifiable net tangible assets (NTA) of the acquired company.

So goodwill will only be found in the financial statements of a company if it has been involved in acquiring other companies.

Negative goodwill relates to a benefit occurring when the price paid for an acquisition is less than the fair value of its net tangible assets.

From an investment point of view, goodwill is similar to other assets such as plant, equipment and property. Hence, the valuation of goodwill should not be ignored.

The value of an asset with associated goodwill may be adjusted over time by management, either by goodwill amortization or by means of occasional adjustments of the estimated value of the associated assets. This is based in the first instance on their ability to generate cash flow and profits.

When analyzing a company with goodwill on its books, I try to evaluate what effect the reported goodwill may have on the future earnings of the company.

Looking ahead, if a company with good management is judged to double its revenues over the next so many years, the amount of assets required to generate this income need not be twice the value of the initial assets, as the goodwill component of the initial assets generally does not increase over time.

The future return on equity and the intrinsic value may be calculated without the reported goodwill.

To Conclude

In financial statements, goodwill is included only if the company has been involved in acquisitions.

If an acquired company continues to grow revenues with a steady profit margin, return on equity should also increase as no additional investment in goodwill will usually be required.

The calculation of intrinsic value by value investors as part of the value investing process should take accounting goodwill into account if it is present in a company's financial statements.

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