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Goodwill is a non-cash accounting entry that arises upon the purchase of a business. On acquisition a goodwill adjustment is made to the purchaser's balance sheet equal to:
- The surplus of the price paid by the purchaser for the seller's shares; over
- The accounting book value of the net assets of the business acquired (= the target business's equity as shown in its balance sheet before any deal).
As mentioned above, goodwill is an accounting entry made upon acquisition and is not a cash flow.
Adjusting an Excel financial model for goodwill
If we were building an Excel financial model for the acquisition of a business and wanted to integrate all the above, the model would contain:
- An opening balance sheet for the business being purchased;
- Adjustments to the opening balance sheet, with significant adjustments relating to goodwill and any increase in new borrowings.
For more detailed information regarding modelling goodwill and other acquisition adjustments, please click on:
http://financial-training-company.blogspot.com/2009/09/adjusting-for-goodwill-in-excel.html
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There are a lot of different steps in a financial modelling build up, starting with laying out the structure of your model in Excel and building in some assumptions. See the related links (further down this page) for the detailed steps to take.
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How do you forecast goodwill in an Excel model?
Goodwill is a class of intangible asset which arises when you acquire a business. Goodwill is the surplus of price paid for the target's shares over the net assets of the target (net assets = book value of equity = total assets less total liabilities = shareholders' equity = shareholders' funds).Writing down goodwill under IFRSUnder IFRS (international financial reporting standards) the value of goodwill is checked each year under an "impairment test" and goodwill is written down if a valuation shows that the acquired target is not worth as much as previously thought. An example is the UK bank RBS's 2007 acquisition of Dutch bank ABN Amro. In 2009 RBS revealed the biggest loss in UK corporate history after it impairment tested ABN Amro and wrote down the value of its investment.Writing down goodwill under other accounting regimesUnder other accounting regimes e.g. UK and Dutch generally accepted accounting practice, goodwill is amortised or written down a little bit each year, just like depreciation on fixed assets.Lessons for financial modelling in Excel - the simple solutionIf you are trying to model an acquisition by a business that accounts under IFRS, the simplest way to model goodwill is to assume no future forecast change. It's not going to make much sense to forecast an anticipated write down or other revaluation and, in any case, it's a not a cash item so doesn't affect the business's economics.The more complicated pictureThe picture above is slightly simplified. When one business acquires another, goodwill is generated as described above. At the same time, the acquirer gets an opportunity to revalue the existing assets of the target upwards. The acquirer gets the opportunity to review the target's existing assets and also identify separate intangibles sitting within the target (e.g. a brand or publishing title that can be valued as a separate intangible asset). In effect, this means that the price the acquirer pays for the target can be broken down into:(i) the fair market value of the target's existing assets and liabilities;(ii) the value attached to separately identifiable intangibles; and(iii) goodwill (equals the surplus of price paid for the target's shares over the value of the other two types of assets).Points (i) through (iii) above provide you with a sense of how balance sheet values could change following an acquisition. In the P&L, following acquisition:(i) revalued tangible assets will be depreciated, increasing depreciation expense;(ii) intangibles will be amortised, increasing amortisation expense;(iii) under IFRS goodwill will be impairment tested each year as per the previous RBS example.In effect the acquisition process gives the acquirer the chance to:(i) 'find' some extra tangible assets that can be depreciated;(ii) 'find' some extra intangibles that can be amortised; and(iii) reduce the amount of goodwill showing on the balance sheet.Lessons for financial modelling in Excel: the more complicated solutionWhen modelling a merger in Excel you could, if you wished:(i) estimate expected revaluations of tangible assets and increases in depreciation;(ii) estimate separately identifiable intangibles and increases in amortisation.ConclusionWithout having gone through a valuation exercise ahead of the acquisition it is going to be very hard to forecast expected revaluations and they are non cash anyway - so it may make more sense to model intangibles as per "the simple solution" above. That is, just calculate goodwill as the surplus of price paid for the target's shares over the net assets of the target and forecast no change/ write down going forward. There are always so many big variables when you are trying to model an acquisition that it's hard to imagine that there is much to gain by super-accurate forecasting of non-cash items.Financial Training Associates Ltd: the CompanyThis answer has been provided by Financial Training Associates Ltd, a company that provides in-house training courses in excel financial modelling training, corporate and projecte finance, valuation and related subjects.
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Ehow.com has several great financial how-to articles including a specific one on how to build a financial model. But there are also several other sites which have how-to's, just search Google for "how to build a financial model".
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It's difficult. Basically you have to go through the model very carefully, tracking everything through (using Excel's formula auditing function) to make sure you know what relates to what.You should also carefully document and log changes you make to the model - so that someone who picks up the model can see exactly what changes you have made and what the impact has been.About the author: Financial Training Associates LtdFTA Ltd is a provider of financial modelling course and other related training for accountancy, law and banking and finance professionals.
