What Is Goodwill?
Goodwill is an intangible asset that is associated with the purchase of one company by another. It represents the value that can give the acquiring company a competitive advantage.
Specifically, a goodwill definition is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process.
The value of a company’s name, brand reputation, loyal customer base, solid customer service, good employee relations, and proprietary technology represent aspects of goodwill. This value is why one company may pay a premium for another.
Understanding Goodwill
The value of goodwill typically arises in an acquisition of a company. The amount that the acquiring company pays for the target company that is over and above the target’s net assets at fair value usually accounts for the value of the target’s goodwill.
If the acquiring company pays less than the target’s book value, it gains negative goodwill. This means that it purchased the company at a bargain in a distress sale.
The process for calculating goodwill
The process for calculating goodwill is fairly straightforward in principle but can be quite complex in practice. To determine goodwill with a simple formula, take the purchase price of a company and subtract the net fair market value of identifiable assets and liabilities.
Goodwill = P−( A − L )
where:
P=Purchase price of the target company
A=Fair market value of assets
L=Fair market value of liabilities
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