Goodwill is the present value of the excess paid for businesses representing acquired intangible assets. The first time I heard of it was a number of years ago in a business class, but the real risks associated with it have taken a while to resonate. I was recently going over a company that looked great. Their profit margins are good, revenue is stable, expenses are somewhat predictable and most of the Wall Street ratios were better than satisfactory. But when it came to the balance sheet, I noticed that a quarter of assets were goodwill.
This may mean absolutely nothing to you or it may sound alarm bells in your head. Goodwill generally does not represent something you can buy or sell, and when you can buy or sell it there are usually abstract estimations of its value. Very occasionally can a goodwill item actually have an accurate number associated with it on the value it might be sold at. Some examples of goodwill items are patents, relationships, and talent.
Goodwill must be depreciated over 40 or less years. Other than that, the values produced are first tied to the business acquisition costs and then more tied to the opinions of auditors and internal accountants.
My old corporate finance textbook recommends that when analyzing the balance sheet, try removing goodwill and maybe the same value from shareholders equity and see what it does to the company's overall health. It may be a decisive factor in reducing your exposure to risk and financial heartache. This correlation between goodwill and shareholders equity is entirely fictional because goodwill is not attributable to SHE directly, but the exercise may nonetheless make the company look much more risky. For the company I was looking at, it certainly made a difference.
The company I was looking at when I came across these figures was Clorox if you would like to see for yourself. The figures are from year end 2020.
Submitted July 12, 2021 at 12:15AM by valuescott https://ift.tt/3AVjv3i
