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Three reasons not to count on goodwill. What does it really tell you?

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.

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.