Elusive Goodwill
January 6th 2007 09:17
When I went to accounting school they told me that goodwill was just an accounting entry. If, for example, someone sold their business that was marked in the books at $1 million for $1.2 million, that $0.2 million was goodwill. Simple.
If your purpose is to make the accounting entries for this transaction I envisage the above knowledge is enough.
For the investor, though, goodwill means something else.
Goodwill, basically, is everything that the business owns that cannot be charged directly into the books but which contributes in an important way to the success of the business.
Examples are: a recognizable business name and brand; a loyal customer base; an effective management structure and stable management team; a history of honourable credit related dealings with banks and other financial institutions. The list could go on and on.
One example to show how goodwill can change the picture for the investor could be this: Company Coca-Cola Co. has $1 billion in assets. So does company New-Cola Co. which starts also with $1 billion in assets.
As it is obvious, both these companies have the same assets and, if you were to be oblivious to the presence of goodwill, you would think that they would be able to make the same net profit by the end of the year.
Company Coca-Cola Co., though, starts with a very well recognised name and stable of brands. It commands the loyalty of millions of customers around the world and it can freely increase its prices.
Company New-Cola Co., instead, is unknown. It will have to invest in marketing its brands and creating some regular customers. That will take a lot of money and time if it wants to compete with Coca-Cola Co..
I have written else were an article titled “Do Assets Make a Company?” where I approach an aspect of this theme.
If you were to be an investor with money enough to buy either of these companies, what value would you put in Coca-Cola Co. and in New-Cola Co.? This is a crucial issue for a company buyer.
Given the unbelievable goodwill placed on Coca-Cola Co., you could feel enticed to give maybe much more than three times Price to Book for it. In fact, the public awareness of this company is so great that it would allow it to make money nearly with anything.
In, comparison, how much value would you place in New-Coke Co.? Maybe the value of its assets, if you want to be commiserative. If you want to be fair, maybe even less, since if the business fails the assets become mere scrap to be disposed of.
Goodwill is in fact elusive.
If your purpose is to make the accounting entries for this transaction I envisage the above knowledge is enough.
For the investor, though, goodwill means something else.
Goodwill, basically, is everything that the business owns that cannot be charged directly into the books but which contributes in an important way to the success of the business.
Examples are: a recognizable business name and brand; a loyal customer base; an effective management structure and stable management team; a history of honourable credit related dealings with banks and other financial institutions. The list could go on and on.
One example to show how goodwill can change the picture for the investor could be this: Company Coca-Cola Co. has $1 billion in assets. So does company New-Cola Co. which starts also with $1 billion in assets.
As it is obvious, both these companies have the same assets and, if you were to be oblivious to the presence of goodwill, you would think that they would be able to make the same net profit by the end of the year.
Company Coca-Cola Co., though, starts with a very well recognised name and stable of brands. It commands the loyalty of millions of customers around the world and it can freely increase its prices.
Company New-Cola Co., instead, is unknown. It will have to invest in marketing its brands and creating some regular customers. That will take a lot of money and time if it wants to compete with Coca-Cola Co..
I have written else were an article titled “Do Assets Make a Company?” where I approach an aspect of this theme.
If you were to be an investor with money enough to buy either of these companies, what value would you put in Coca-Cola Co. and in New-Cola Co.? This is a crucial issue for a company buyer.
Given the unbelievable goodwill placed on Coca-Cola Co., you could feel enticed to give maybe much more than three times Price to Book for it. In fact, the public awareness of this company is so great that it would allow it to make money nearly with anything.
In, comparison, how much value would you place in New-Coke Co.? Maybe the value of its assets, if you want to be commiserative. If you want to be fair, maybe even less, since if the business fails the assets become mere scrap to be disposed of.
Goodwill is in fact elusive.
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