Three reasons goodwill can mislead a lender
Even if the balance sheet is correct…
Did the buyer guess right?
So the first problem with goodwill is that we are counting on the acquiring company to have guessed at the amount correctly. Do they have the knowledge and judgment to assess the reputation, brand, personnel and other intangible value of the acquired company accurately.
You cannot use it if the loan goes bad.
The second problem is that as an intangible, if something goes wrong, it is not collateral you can get your hands on. Most lenders and credit analysts attending my Financial Statement Analysis training tell me they subtract intangible assets when calculating Return on Assets or any ratio that includes assets in the mix.
Goodwill can change very quickly.
The third problem is that these intangibles can change based on what the acquiring company does. A company can enhance reputation by their actions. But they also can kill it. Have you ever been in a store that recently changed hands and decide you won’t be back? Or been pleasantly surprised? That is because what the new owners have done has either detracted from or enhanced customer service, product selection, cleanliness of the store, or something else that is important to you.
What it does tell you…
If the Balance Sheet is based on Generally Accepted Accounting Principles (GAAP), the existence of Goodwill in the asset section shows the company acquired another company. And in this company’s judgment, the other company was worth more than the value of the tangible assets (inventory, equipment, buildings) included in the purchase.
Good to know, but I would not read a lot more into it unless you have a great deal of confidence in the judgment used and are comfortable that nothing has eroded that goodwill.
