What Is the Goodwill to Assets Ratio?
The goodwill to assets ratio measures the proportion of a company's goodwill, which is an intangible asset, to its total assets and is a factor in that company's valuation. Goodwill represents the value of a company’s brand name, solid customer base, good customer relations, good employee relations, and proprietary technology, etc.
The average goodwill to assets ratio varies from industry to industry. It is best to compare goodwill to assets ratios within industries to get a feeling for what is typical. Then, industry outliers can be identified.
- The goodwill to assets ratio measures the proportion of a company's goodwill, which is an intangible asset, to its total assets and is a factor in that company's valuation.
- The ratio quantifies a company's brand value and other intangible aspects of its valuation.
- A larger goodwill to assets ratio suggests that the company's value is not primarily in its tangible assets,
Understanding the Goodwill to Assets Ratio
To grasp the significance of the goodwill to assets ratio, it is important to remember that goodwill is an intangible asset which means that it cannot be valued as easily as one could a physical asset. Essentially, the goodwill to assets ratio is a way to see what percentage of a company's total valuation is due to its reputation as opposed to its tangible assets.
Goodwill is often generated as the result of an acquisition. If this ratio starts to increase rapidly, it can indicate the company is on a buying spree. If a company is increasing its total assets by acquiring other companies and goodwill is an increasingly large portion of the newly formed company's assets it could potentially lead to future asset-level instability for the newly formed company. In addition, the amount of goodwill a company maintains can be changed quickly if the company decides to write down the amount of goodwill they have on the books.
Interpreting the Goodwill to Assets Ratio
A small goodwill to assets ratio will indicate that a large portion of a firm's total assets is comprised of tangible assets or material items the company can sell for monetary value. Intangible assets are not easily separated from the company or liquidated for monetary gain.
A company with a large starting goodwill to assets ratio may experience a significant swing in the value of their total assets—and overall company valuation—if they write down a large portion of their goodwill when their asset base was heavily composed of goodwill, to begin with.
Goodwill to Assets Ratio Calculation and Example
The goodwill to assets ratio is calculated by dividing goodwill, which is usually found in the no-current assets section of a company's balance sheet, by total assets.
Goodwill To Assets Ratio = Goodwill [Purchase price + (Liabilities - Assets)] ÷ Total Assets
For example, if a company is sold for $5,000,000 and its total assets are $3,500,000 and liabilities are $750,000.
Goodwill To Assets Ratio = [$5,000,000 + ($750,000 - $3,500,000)] ÷ $3,500,000 = 64.3%