Do you remember your childhood days when you used to do some good thing and you were treated by your parents for doing that good deed? Did it feel like an accomplishment to you? Something of more value than any other toy of yours? The same applies to your business! If you do good in it, maintain good terms with your customers and allies and build up a name of recognition, you'll gain your business an intangible asset called - Goodwill.
Goodwill stands on pillars like trust, loyalty, a permanent customer base, a strong reputation and a record of existing contracts. Goodwill, in business terms, is just more than your business's behaviour. It is built over the years of the business's existence and due to its non-physical form of existence, it cannot be derived to please an exact and quantified value. Though anything that adds value to the business beyond its assets and liabilities is considered goodwill.
Goodwill comes to highlight when you are either buying a business or selling yours. Anything that exceeds the sum of tangible or intangible assets and liabilities is the goodwill of the business.
To get an estimated value of the goodwill in business, there's a formula for the same-
Goodwill = Purchase Price- (Assets + Liabilities)
(Here, the purchase price refers to the market value of the business)
After all, anything worth having costs you something!
Goodwill concerns your business because all the things that can not be touched or felt come after the monetary and skill investment. And hence, it has a cost to pay.
Goodwill has its types depending on how they are calculated:
This type of goodwill includes your reputation in the market, the position of the business and the customer service provided by the business.
Professional goodwill covers the skills offered by professionals, like lawyers, doctors, accountants, engineers and more.
Goodwill doesn't always need to be positive. Negative goodwill has the opposite effect of positive goodwill. To have a strong representation and a better worth of your business, it's necessary to build up positive goodwill or else it would depreciate your business's worth in the future.
When you buy or sell your business, there are certain limitations to your usage of goodwill from the business. The negative goodwill that you purchase would come under the acquirer's income statement. And when the business becomes insolvent, the investors’ dedicated goodwill from the business's residual equity. This is because the business that previously held a goodwill worth, has no resale value any longer, after the insolvency.
Here is an example of goodwill in the purchase or sale of the business. Facebook acquiring Instagram could help you know how goodwill is important for your business.
When Facebook acquired Instagram, its market worth was assumed to be around $500 million, but after the evaluation of the total assets and liabilities of Instagram, it came out to be worth $1 billion. This rise in its worth was found to be a cause of Instagram's goodwill.
Therefore, positive goodwill enhances your business's price and keeps your investors and shareholders happy. Goodwill, hence, is more valuable than all your visible assets, as it reflects the total worth of your business's market value.