Goodwill Calculation for a Business

The value of a business goes far beyond a collection of assets, inventories or a list of services. A whole series of intangible assets are usually a big part of it, including its brand name, its reputation and its loyal customer base. These intangible assets are referred to as business goodwill. When a business is sold, goodwill accounts almost always accounts for a part of the sale price, and is sometimes its largest component.

Business Goodwill Value

Goodwill is almost always a factor when a business is being sold. Suppose, for example, you owned a small restaurant with great reviews online and a loyal customer base who filled the tables regularly on a daily basis, generating a $5,000 net profit every month. A list of assets may only be the kitchen equipment, tables and chairs – assuming you leased the building. Your assets would only amount to a couple thousand dollars, yet your business is certainly worth more than that. Any amount you sold it for, above the value of its assets, would be classified as goodwill.

Goodwill can include almost any intangible quality of a business that makes it more valuable than just its assets. These could include word-of-mouth name recognition due to years of advertising, a great reputation for customer service, or anything else that contributes to the company's net revenue that can't be accounted for based solely on its assets.

A relatively modern example of the value of goodwill is when someone sells a domain name. In itself a website domain name has no value, beyond the registration fee, which is usually a few dollars each year. Yet, to get a memorable domain name that will perform well in Google searches, companies are willing to pay thousands, or even millions of dollars. In 2017, for example, Walmart bought the website for a whopping $9 million. While additional intellectual property was included in the sale, including graphics and social media accounts, almost the entirety of the purchase price could be attributed to goodwill.

Calculation of Goodwill Formula

The IFRS 3 – Business Considerations, issued by the International Financial Reporting Standards Foundation, provides a formula for calculating goodwill when buying or selling a business. To state it briefly, goodwill is calculated by what the buyer gives the seller for the business minus the value of the net assets. Net assets include everything of value owned by the company, including property, inventory, vehicles, etc., minus any debts like bank loans or bonds. The formula only appears complicated if the payment includes things like stocks or a percentage of ownership in the buyer's company. The complete formula is:

Goodwill = Consideration transferred + Amount of non-controlling interests + Fair value of previous equity interests - Net assets

Note that this calculation is done on the date of purchase.

Goodwill Accounting

Because goodwill has a real value, it should be included on a company's balance sheet after a purchase. While it may be tempting to see this as an asset that's being created just to balance the books, it's more correctly viewed as a very real asset – albeit an intangible one – that is part of the company's value.

In the past it was up to the new owner to review the value of the goodwill and to adjust that value should any factors over the course of a year cause it to become impaired. For example, if you were to rename a restaurant, hire a new chef and change the menu, this could cause the value of the purchased goodwill to be diminished. This is called the impairment method.

Today, generally acceptable accounting standards, or GAAP, allow private companies to amortize goodwill on a straight-line basis over a 10-year period. This is called the amortization method.