Business goodwill is an intangible asset owned by and associated with the operation of a company. The goodwill of a company increases its value, as qualities such as the company's customer base, its brands, products, location, workforce and reputation demonstrate the company's proven track record of generating income.
The Effects of Goodwill on Corporate Value
All this means that the company's value is actually greater than its combined raw assets. The effect of goodwill on a company's value is better understood by learning the factors that create business goodwill.
The three factors in the creation of a company's goodwill include its going concern value, excess business income and the expectation of future economic benefits.
- The going concern value indicates that the company is already able to produce income by applying existing capital (equipment, employees, management and resources) effectively.
- The excess business income implies that a company is earning excess income due to the presence of its goodwill.
- The overall value further increases when expectations for economic growth are added to the equation, as the company is expected to attract new customers and create more products, resulting in added wealth.
How Business Goodwill Is Determined
The goodwill of a business is typically determined by subtracting the fair market value of the tangible assets from the total business value.
Business goodwill is also determined by the capital surplus earnings method, which calculates the fair market value of the business assets, determines the fair rate of return on said assets and subtracts the return from the company's total earnings. The resulting excess earnings are considered the goodwill of the company.