The financial measurement called goodwill to assets is used to compare the intangible assets of a company – like a customer list, brand name, and its unique position in the industry – to the number of the company’s total assets. The result shows if the goodwill is recorded properly within that company.
Basically, goodwill can also be seen as reputation. This time, it may not be all about profit – instead, companies use this measurement to value their current reputation in a monetary form. Naturally, as important as it may be, goodwill can’t show a company’s success alone and it is, therefore, compared with the other assets of the company when determining its value.
The Basics of Goodwill to Assets
In short terms, the goodwill to assets ratio is used to show how a company’s namesake power and its definitive assets stand next to one another – it measures their relationship.
The IFRS and GAAP accounting rules state that the management is responsible for tracking and valuing goodwill. This leaves a company’s management, creditors, and investors with the task of reviewing assets and carefully distinguishing between tangible and non-monetary assets.
This is a measurement that has to be paid attention to when calculated. For example, if the one that measures it gives too much value to a company’s reputation or brand name, the true financial picture of the latter might remain hidden, as well as a number of potential problems.
The Formula of Goodwill to Assets
In order to come up with the goodwill to assets, management, investors, and creditors have to use a very simple formula – they just have to divide the total assets by the total goodwill. The later can be found on the balance sheet of the company.
Also, one has to keep in mind not to confuse intangible assets and goodwill. Even though both of the aforementioned are basically intangible, goodwill is reserved for those items that are not usually found on a company’s balance sheet, namely, brand awareness and reputation.
In short, goodwill represents the difference between all of the defined assets of a certain company and its total asset valuation.
The goodwill to assets ratio is best applied in the case of a company that purchases another company. For example, if a company buys another company for $50 million, but the second company was valued at only $10 million, then the goodwill value that is going to be recorded on the balance sheet is of $40 million.
Of course, the remaining $10 million are recorded as an asset purchase. Naturally, only goodwill will appear on a company’s balance sheet if they have successfully purchased an asset or another company – but, for more than the fair market or book value of that asset or company.
Investment analysts and shareholders keep a close eye on a company’s goodwill, as it determines how its value is affected by acquisitions and mergers. For example, if a company’s goodwill to assets ratio is decreasing, it may mean that other company assets have their value increased or that its brand image might have been marred.
Therefore, a low goodwill to assets ratio can’t be always seen as a bad sign.