What is goodwill in business?
As a business person, goodwill is a term you will hear during your business operations.
When you hear the word “goodwill,” several things will likely come to your mind.
As simple as the word seem, it is often challenging to come up with a clear definition for the term in individual businesses.
However, you need to know what it means, as it will help you figure out if it is something you have to prioritize or consider in your business operation.
This article will help you better understand goodwill in business and clear any confusion you have concerning it.
So let’s get started.
What is Goodwill? – What Is Goodwill in Business
Goodwill in business refers to the positive image reputable companies have in the mind of their employees, customers, and the general public.
Also, it is the collective intangible attributes of businesses that can lead to higher customer morale, greater brand recognition, and increased customer loyalty.
All of these further lead to an increased earning capacity of a company.
Hence, goodwill is considered to be an intangible asset of great value.
Although goodwill does not have physical forms, its existence increases businesses’ value or selling price.
Goodwill often comes to play when a business is to be sold.
This is because they are assets that influence the value and profitability of a business.
Types of Goodwill – What Is Goodwill in Business
Although goodwill includes the intangible assets a company has, they are still categorized into different types, and they are as follows:
Purchased Goodwill
Companies acquire purchase goodwill when they buy another company or assets.
They usually list its value as intangible assets on balance sheets.
The customer base and reputation of the acquired company are often associated with this type of goodwill.
Inherent Goodwill – What Is Goodwill in Business
Companies create and accumulate inherent goodwill over time through their efforts and hard work, such as:”
- Building strong brands.
- Providing excellent customer service.
- Marinating a good reputation.
Inherent goodwill does not reflect on balance sheets, unlike purchased goodwill.
However, people still consider it a valuable asset.
These types of goodwill can be tarnished if a company goes through negative events or experiences such as financial mismanagement, ethical scandals, or product recalls.
Additionally, a reduction in the value of a company’s goodwill can negatively affect the company’s bottom line and reputation.
Therefore, to avoid this for your company, you need to actively maintain and protect your goodwill by monitoring your business reputation.
You should also have strong governance and implement strategies for risk management.
Factors That Affect Goodwill – What Is Goodwill in Business
Several factors can affect a business’s goodwill.
Brand Reputation
A strong brand reputation is one of the most important factors in creating and maintaining goodwill in the business.
In other words, a business that doesn’t provide high-quality products or services has a poor image and is irresponsive to customer complaints and feedback will have poor goodwill.
Customer Service – What Is Goodwill in Business
Poor customer service can affect your company’s goodwill.
This is why investing in excellent customer service is highly recommended.
A business that fails to respond to customer needs addressing concerns and complaints promptly and professionally will have poor goodwill or none.
Hence, you should be capable of meeting and exceeding your customers’ expectations.
Financial Stability
A company’s financial stability can also affect its goodwill.
If a company faces financial difficulties, it can lead to a loss of trust and confidence from customers and investors.
This can, in turn, lead to a loss of goodwill.
Business Ethics – What Is Goodwill in Business
A company’s ethical behaviour can also significantly impact its goodwill.
In other words, if your business is not transparent, honest, and fair in all its dealings, people will not trust it.
The same is applicable if it does not engage in sustainable business practices and support the local community.
People need to know that your business has integrity and good business ethics to trust it.
Crisis Management
A company’s ability to manage crises, such as product recalls or scandals, can also affect its goodwill.
How a company handles and communicates during a crisis can either mitigate or aggravate the damage to its reputation.
A company that experiences damage to its reputation will lose its customers and other stakeholders’ trust, drastically reducing its goodwill.
Industry Trends – What Is Goodwill in Business
Changes in industry trends can increase or decrease competition for a company.
If competition increases, it can become more difficult for a company to maintain its reputation and customer base, consequently leading to a decrease in goodwill.
Also, industry trends such as technological advancements can cause a company’s goodwill to decline if it is not quick to adopt new technologies in its operations.
How to Create Goodwill – What Is Goodwill in Business
Goodwill can either be acquired or created.
As a business owner, you should be more concerned with creating goodwill for your company.
So, how do you create goodwill?
Here are some steps you can follow to create goodwill in your business:
Develop a Strong Corporate Culture – What Is Goodwill in Business
Establish core values that align with your company’s mission and vision, and ensure your employees understand and follow them.
This will help create a positive image of your company internally and externally.
Provide Exceptional Customer Service
Ensure your customers are always treated with respect and that their needs are met promptly and professionally.
This includes being responsive to customer complaints and feedback and going above and beyond to meet customer expectations.
Be a Responsible Corporate Citizen – What Is Goodwill in Business
Engage in sustainable business practices and support your local community.
This act of corporate social responsibility can create a positive company image and increase community support for your business.
Be Consistent
Consistency is important for building and maintaining anything.
The same goes for creating goodwill.
All you need to do is keep delivering on your brand promise and ensure your customers have a positive experience with your company.
Build a Strong Brand – What Is Goodwill in Business
Develop a strong brand identity that reflects the mission and value of your company.
This includes creating a consistent visual identity and messaging and building a strong online presence.
Have a Crisis Management
Have a crisis management plan to handle unexpected events that can damage your goodwill.
This plan should include procedures for dealing with crises, such as product recalls or scandals.
Also, you should have communication strategies for addressing the stakeholders and the public.
Creating goodwill takes time and effort, as it is not a one-time action.
It requires consistent effort to maintain and protect it.
If you follow the steps, you will create and maintain a positive reputation for your business and ultimately increase customer loyalty and profitability.
Importance of Goodwill – What Is Goodwill in Business
Creating or having goodwill in your company makes people feel happy with your business and helps you build long-term business relationships that can ensure success.
If you succeed in creating or acquiring goodwill for your company, here are some of the benefits you will enjoy:
Promotes Brand Loyalty
Brand loyalty is when people are only interested in using your company’s products and services.
To these people, no other brand does it well for them as much as your brand does.
So they stay loyal to your brand.
In a nutshell, creating goodwill in your company helps to encourage brand loyalty.
Your customers will be satisfied and happy with your services and products and will keep patronizing your business.
Not only will they do business with you, but they will also refer your business to other people.
This automatically helps to increase your customer base.
Provide Competitive Advantage – What Is Goodwill in Business
When there are similar products with similar price points, customers often struggle to choose the brand to go with.
However, if your company has goodwill, it will provide a competitive advantage.
Customers will not struggle to choose when your brand is in the mix.
Rather, they will be persuaded to go for your brand or product because of your company’s reputation.
Improves Business Value
Your business value can increase due to its goodwill.
This is because goodwill makes your stakeholders satisfied with your company and more interested in doing business with you all or most of the time.
As a result, this helps to increase your profitability.
Investors and business appraisals know that businesses with high profitability have more value than others with lesser profitability.
Simply, goodwill improves your business value, attracts investors, and gives you a better chance at securing credits and loans.
Also, if you decide to sell your company, you will have more command in sales as you know that you are offering to sell a company with great value.
Encourage Forgiveness – What Is Goodwill in Business
When you have someone good to you, most of the time, you will likely find it easier to forgive them if they offend you.
The same applies to companies that have created goodwill with their stakeholders.
When you make a mistake or offend your customers, they will likely forgive you easily and work with you to correct the mistake.
This can only happen when you have made it a habit of providing the best services and doing other things to please them.
Valuation of Goodwill in Business – What Is Goodwill in Business
Goodwill is also considered an asset in business.
Hence, it undergoes valuation just as other asset does.
So, goodwill valuation is the process of determining the monetary value of the goodwill of a business.
Valuing goodwill involves estimating the future income that a business will generate and then capitalizing the income to arrive at a value.
This is done by a professional appraiser or valuator who uses specific methods.
Their methods are based on their professional judgment, industry knowledge, and company-specific information.
Methods for Valuing Goodwill in Business – What Is Goodwill in Business
There are several methods for valuing goodwill in a business, but the most commonly used methods are:
Income Capitalization Method
The income capitalization method involves estimating the future income that a business will generate and then capitalizing that income to arrive at a value for goodwill.
In other words, it is based on assumption.
The assumption is based on the idea that a business can use its future income to generate a rate of return on investment.
Market Capitalization Method – What Is Goodwill in Business
This method involves looking at the market capitalization of publicly traded companies in the same industry.
The information obtained from those companies is then used to estimate the value of goodwill for a privately held company.
This method is based on the assumption that the market value of a publicly traded company reflects the value of its goodwill.
Cost Capitalization Method
The cost capitalization method involves estimating the cost of creating the goodwill and then capitalizing the cost over some time.
It is based on the assumption that the cost of creating goodwill can be used to generate a rate of return on investment.
Asset-Based Method – What Is Goodwill in Business
This method subtracts the value of tangible assets and liabilities from the total enterprise value.
The result of the calculation is what is concluded to be the value of goodwill.
Unlike the other method of goodwill valuation, the asset-based method is not based on assumption.
Importance of Goodwill Valuation – What Is Goodwill in Business
Goodwill valuation is important for several reasons:
Mergers and Acquisitions
Goodwill valuation is often used in mergers and acquisitions to determine the value of a company and its assets.
Knowing goodwill’s value can help you make informed decisions about whether to pursue a merger or acquisition.
Also, it can be used to negotiate the terms of the deals.
Financial Reporting – What Is Goodwill in Business
Goodwill valuation is also important for financial reporting.
Companies must record the goodwill value on their balance sheet and test it for impairment annually.
Goodwill is considered an intangible asset, and its value is affected by a company’s performance and market conditions.
Therefore, an accurate goodwill valuation is essential for providing factual financial statements and making informed business decisions.
Taxation
Goodwill valuation is also important for tax purposes.
The value of goodwill can affect the amount of taxes a company owes, particularly in the case of mergers and acquisitions.
Knowing goodwill’s value can help companies plan for and manage their tax liability.
Litigation – What Is Goodwill in Business
Goodwill valuation may also be important in the context of litigation.
For example, in a divorce case, if a business is considered a marital asset, then the court will need to determine the value of the business.
And this will include goodwill.
How to Record Goodwill on Your Business Balance Sheet – What Is Goodwill in Business
Goodwill is recorded on a business’s balance sheet as an intangible asset when it is acquired.
The process of recording goodwill on a balance sheet involves the following steps:
Identify the Amount of Goodwill
The first thing you are to do is to identify the amount of goodwill.
In M&A, companies typically identify and record goodwill as part of the purchase price of a business or assets.
However, usually, the amount of goodwill is the difference between the fair market value of the assets and liabilities of the business and the purchase price.
Record the Amount of Goodwill – What Is Goodwill in Business
On the balance sheet, under the section labelled “intangible assets,” the company records the amount of goodwill as an intangible asset.
Business people consider goodwill an asset because it has the potential to generate future economic benefits.
Disclose the Amount of Goodwill
The balance sheet should also include a note explaining the nature of goodwill and how it was valued.
This note should also disclose any uncertainties that relate to the goodwill.
Test the Goodwill for Impairment – What Is Goodwill in Business
The next thing to do is to test for impairment at least annually.
This test involves comparing the reporting unit’s fair value (the business unit or segment) to its carrying value, including goodwill.
If the carrying value exceeds the fair value, the company recognizes an impairment charge to reduce the carrying value to the fair value.
Review and Update the Value of Goodwill
Companies review and update goodwill value as necessary to ensure it is correct and reflects their current situation.
You can do this through regular review and update to the balance sheet and through testing for flaws.
However, you need to understand that the accounting standards and regulations may vary by state and region.
So, to know the correct way to record and disclose goodwill on the balance sheet, you should consult an accountant or financial advisor.
Conclusion on What Is Goodwill in Business
Goodwill is an intangible asset that represents the positive reputation and image of a company in the mind of people.
It is a valuable asset that can increase customer loyalty, employee morale, and other things that enhance a company’s profitability.
Thankfully, we’ve shared information on how to develop goodwill for your business.
So, get to work and start building one for your business today!
