Goodwill: A Financial Illusion

Goodwill is one of the stupidest things in the world of finance. It's pure make-believe. It's the bitcoin of balance sheets. You can't see it, use it, and no one seems to know exactly what it is, but trust us, it's there.

Yea, no thanks.

Whenever you see a sizeable chunk of goodwill on a balance sheet, your spider senses should activate. Do a quick assets test. Remove goodwill from the equity and see what's left. You might discover that big bottom line equity is nothing but hot air. A company with billions of dollars in assets at first glance, might just be sitting on a pile of debt

So, how is goodwill created you might ask?

It's simple.

If one business buys another, then the acquired assets show up on the buyer's balance sheet. This includes two types of assets.

l Tangible assets: Real estate, inventory, equipment, loans, vehicles, accounts receivable, cash etc.

l Intangible assets: Brand names, commercial licensing agreements, patents and trademarks. They aren't physical things, but we can identify and isolate them.

But it's not only assets. Liabilities are also inherited, including borrowings, lease liabilities, accounts payable etc.