What is this ethereal, intangible, invisible asset of goodwill?

‘Goodwill is often things you can’t see or feel, but which can be worth large amounts of money.’
Issue date: 22 February 2008

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What was your first memory of the word “goodwill”? Probably much like mine – from the nativity plays we were drafted into as kids, with an angel announcing “Glory to God in the highest, and on earth, peace, goodwill toward men.” Now, we know this was not an accounting discussion, but let’s consider “goodwill”, which in ancient accounting parlance would have been called a misunderstood concept.

Let’s assume that on 31 December 2007 your company’s balance sheet, as depicted in Table 1 below, reflects tangible assets of land, buildings, machinery, receivables and cash worth R2,5 million, and liabilities made up of bank overdraft and payables of R1 million. The net asset value (NAV) of the business is R1,5 million. Now let’s assume you buy the neighbours’ company with a NAV of R750 000 as depicted in Table 2, but because it makes such good sense to consolidate it with your present business, you agree to pay R1 million, which is R250 000 more than the NAV. You’ve got R750,000 in cash and you take out a bond to secure the balance of R250,000 which gives you the million you need to pay the neighbour.

Let’s now have a look at the combined balance sheet of the new business as depicted in Table 3. Follow the logic in the tables from left to right. The assets and liabilities of the new company are simply a combination of the assets and liabilities of the buyer and seller, adjusted (a) for the cash paid by the buyer to the seller and (b) for the buyer’s new debt incurred to secure the full purchase price. However, the R250 000 paid over and above the NAV is not forgotten, and voila, the term “goodwill” pops up on the balance sheet of the new company.

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It’s the money paid for the intangible asset of, in this case, the benefits of merging the two businesses. It’s often paid for things like trademarks and other so-called intellectual property, which you can’t see or feel, but which can be worth large amounts of money. Goodwill is often worth far more than the tangible assets of the business, so never forget about it when the day comes for you to sell. – E-mail [email protected] or call (013) 745 7303).