Decoder: The value of 'goodwill'
Rico Gagliano explains what the term "goodwill" means in financial circles.
A stock trader watches a monitor at the New York Stock Exchange. (Timothy A. Clary/AFP/Getty Images)
More on America's Financial Crisis, The Marketplace Decoder
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KAI RYSSDAL: Marathon Oil released earnings today. The numbers gave investors a bit of a shock. No Exxon-Mobile record-breaking billions here. Red ink, in fact.One of the biggest factors in the quarterly loss was a $1.4 billion writedown of something called "goodwill." Which means what, exactly?
Marketplace's Rico Gagliano helps us out in today's installment of the Marketplace Decoder.
RICO GAGLIANO: OK. To understand the concept of "goodwill," let's cast our minds back to the heady days of the dot-com era.
JAMES ANGEL: Investors were buying dreams.
That's James Angel, finance professor at Georgetown University.
ANGEL: Many companies were little more than an idea in somebody's laptop computer. Yet, many investors were willing to pay good money to invest in those companies because they expected those companies to go out and make a lot of money in the future.
That value -- the value of a company's future profit-making potential -- is called "goodwill." Goodwill is what makes the Coca-Cola company worth more than the value of all the bottling equipment and sugar water it owns. Or, OK, how's this for a metaphor?
ANGEL: If you think of a company as being like a work of fine art. The value of the painting is not the value of the paint and the brushes and the canvas. The value of the painting is what the market will pay for it.
In other words, Goodwill is pretty subjective -- but only up to a point. See, the moment a company is sold, accountants can assign an exact dollar value to its goodwill. They just add up the value of all the company's assets and subtract that from its selling price.
ANGEL: Then there's a leftover amount which reflects the buyer probably paid more than the sum of the market values of all the individual pieces of the company. And that's called goodwill.
Here's the neat part. Let's say you bought that company. Its goodwill is now considered one of your assets. It appears on your balance sheet just like office equipment or company cars. And your accountants can calculate whether that goodwill value is increasing or decreasing. If the value decreases, you can put that down as an expense. And if an agency like Moody's suspects the value might decrease? They can downgrade your credit rating.
At which point you might find yourself shopping at that other Goodwill.
In Los Angeles, I'm Rico Gagliano for Marketplace.
Comments
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From Hong Kong, 03/10/2009
Matt, good will is a combination of:
- net asset values
- value of the target companies competitive advantage
- value of the staff that come with the organization
- discounted future cash flows
- and more
However, good will is accounted for as purchase price minus net asset value.
Good will is an asset that eventually must have its value written down (impaired).
From Los Gatos, CA, 02/09/2009
Strictly speaking.. the "goodwill" value is the difference between the purchase price at teh time of acquisition and the book value of the enterprise acquired. So if I buy a company for $10M with a book value ( value of its assets ) of $1M, I have on my balance sheet $1m in assets and $9M of goodwill. This is so you don't take a hit of $9M on your balance sheet when you make an acquisition; Most ongoing enterprises are worth much more than their book value. The problem arises when the justifiable valuation of the acquired enterprise drops. If the company you acquired for $10M, suddenly doesn't seem to have great prospects, the $9M in goodwill is"impaired", meaning that you have to write it down on your balance sheet, which creates a non-cash charge.
From tulsa, OK, 02/04/2009
I heard on the radio show Rico (I believe), say that the value of good will is the difference between the sale price of company and the total value of it’s assets. Wrong. The sale price of a company is largely determined by the future earnings potential. Some may say that the future earnings is based on good will, and perhaps to some degree this true. But future earnings is far more driven by the market for the product or service that company sells.
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