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What is Business Goodwill?

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The term business goodwill is used quite often in many different contexts but is often misunderstood. The problem may be that business goodwill is an intangible accounting concept and not something that we can touch or measure directly. Business goodwill is that portion of the value of a business that exceeds the value of the tangible assets of a business such as equipment, inventory, etc. Goodwill is an important concept because in a sense it is a key measure of how successful a business has been operated and managed.

 

In its simplest form, the value of a business consists of the market value of tangible assets plus its goodwill value (or intangible asset value). Tangible assets are physical items such as equipment, inventory, furnishings, fixtures, accounts receivables, etc. whose value can be directly measured. The value of these tangible items can be fairly accurately estimated based on available market comparisons. Generally, goodwill is that portion of business value that cannot be accounted for or allocated to tangible assets. Goodwill is generally considered to represent the value of a business in excess of its tangible value resulting from a combination of many things including but not limited to strong sales and earnings history, having an existing customer base, having on-going operations, business systems in place, reputation, key employees, brand value, trade names, trademarks, patents, etc. Goodwill is a positive indicator of the strength and health of a business. 

 

As an example of estimating goodwill value, if a business is appraised at an asset value of $2 million and has $1 million of appraised tangible assets such as equipment, inventory, accounts receivables, etc. then its goodwill value is $1 million (i.e., $2 million business value less $1 million tangible asset value). Any qualified business appraiser will acknowledge that the more profitable, less risky and healthy a business, the higher its goodwill value will be when compared to a similar but less profitable, more risky and weaker business. Alternatively, a business with $0 goodwill value would generally indicate a business that is distressed and not earning a market rate return on its invested capital. In other words, high goodwill value indicates a business is generating an excess return on investment in tangible assets.

 

Probably the best examples of goodwill value are service businesses. Service businesses like consulting practices, law firms, dental practices, medical practices, accounting practices, engineering firms and similar businesses have relatively little in the way of equipment, inventory and other tangible assets compared to manufacturing, wholesale or retail businesses but can still be of significant value. That is because the majority of the value of a service business is in the form of hard to directly measure goodwill value.

 

At the end of the day, the fundamental driver of business value is the income stream or earnings that a business generates. Business owners don’t own businesses to own assets, they own assets to earn the maximum income possible. Business goodwill captures the intangible value of a business over and above the value of equipment, inventory, accounts receivables and other tangible assets.