The term ‘goodwill’ is often heard in business circles and even in normal conversation between buyers and sellers at any local market. As students of commerce, you probably already know that it is an intangible asset. But, there are several other aspects that comprise goodwill meaning, the details of which are given below.
Goodwill is an intangible asset that exists between two companies when one is in the process of buying the other. It may also exist between a business and consumer, but for the sake of simplicity in understanding goodwill meaning, only the former condition is chosen. When company ‘A’ is willing to purchase company ‘B’ at a sum greater than ‘B’s tangible assets, goodwill exists. Such assets will comprise various aspects including brand value, fair employee and customer relations, Intellectual Property and patents, among some others.
How is Goodwill Calculated?
The following is a common goodwill formula used for its calculation.
Goodwill = P - (A+L)
P represents the price of the company being acquired.
A represents the fair/justified asset value.
L represents the fair/justified liabilities outstanding.
Types of Goodwill
There are 2 types of goodwill which are commonly found in the world of business.
Purchased Goodwill: When a company acquires another as a ‘going concern’ and pays a value including the latter’s total assets but barring its outstanding liabilities, it is declared as purchased goodwill.
Inherent Goodwill: When a company purchases another but makes no distinction between the assets and liabilities, and yet pays a sum higher than the latter’s fair market price, it is a classic example of inherent goodwill.
Real-World Example of Goodwill
A classic example of nature of goodwill and how it affects businesses was observed in 2018 when the US telecom giant T-Mobile acquired Sprint. With the new entity to be named ‘New T-Mobile’ the deal was cleared only in late 2020 after regulatory wrangling. The S-4 filing revealed that as of March 31, 2018, the deal was valued at $35.85 billion.
A. What is Goodwill?
Goodwill is an intangible asset common in business circles valued especially when mergers and acquisitions take place. If a company has goodwill, it is more likely to have a greater selling price during an M&A process. A loyal client base, efficient management, superb branding and effective advertising, among some other criteria, constitute goodwill meaning and its valuation for any company in the long run.
B. What Are The Types of Goodwill?
There are 2 main types defined as far as the essential features of goodwill are concerned: purchased and inherent. When a company (A) purchases another (B) by subtracting the latter’s liabilities from assets, it is a purchased goodwill. When another company (C) purchases yet another entity (D) but without distinguishing between the assets and liabilities, it is classified as inherent goodwill.
C. How Is Goodwill Calculated?
The common formula to calculate goodwill is the following:
Goodwill = P − (A+L)
P is the fair price of a company
A is the fair asset value
L is the fair value of liabilities outstanding of the company being bought.