The Oxford dictionary defines goodwill as:
“The established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold.”
Goodwill exhibits many of the characteristics of other forms of property:
- It meets the definition of an asset under accounting standards: it is an intangible asset.
- Companies, businesses and other forms of enterprise are sold every day with a component of goodwill.
- Goodwill can be transferred with the business.
- The value of goodwill can be protected by legal action.
But goodwill does not exist on its own, it must be attached to a business and cannot be dealt with independently of the business.
The accounting standards require that purchased goodwill be measured as the difference between the purchase consideration and fair value of identifiable net assets. Essentially goodwill is a residual value. When calculating goodwill, the final value attention should be carefully reviewed to ensure the result is reasonable.
Why is this important? In many cases, the unknown factor in business valuations is the value of goodwill. The value of goodwill can be increased obviously by increasing profits but also by the documentation of its components including the business processes and procedures. A further simple measure to increase goodwill can be a vendor providing proper handover to a purchaser. Therefore, measures to decrease risk.
Examples
- When valuing rent roles there is an industry rule of thumb calculation that is often applied such as 2.8 times commission revenue. Care should be taken that the resultant value is commercial. That is a buyer will obtain a commercial rate of return on the investment.
- By definition, goodwill is the residual value after deducting net tangible assets. The value of goodwill cannot exceed the total calculated value of a business, say as calculated under the capitalisation of future maintainable earnings method. Recently I was requested to critique a valuation where the calculated value of the business was $641,000 (including all tangible and intangible assets and liabilities) and yet the calculated value of goodwill was approximately $1.9 mil.
At Hymans, we can work with you to get your business ready for sale. If you are looking to sell your business, we can assist in documenting the components of goodwill, business processes and procedures with the aim of maximising sale value.
If you have any enquiries, feel free to contact Ross Mottershead on 0413759242 or Ian Hyman on 0416151597.
Contact.
There’s no job too big or too small for the team at Hymans and we always strive to deliver on our clients specfific needs, so please reach out for an obligation free chat about how Hymans can help.
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