What is meant by the term goodwill?

Answer 1

Goodwill is an asset on the balance sheet. It is created when a business is purchased, if the buyer is willing to pay more for the business than the fair market value of the assets such as inventory and equipment.

The buyer might be willing to pay more because an existing business may have

* built up a good reputation, * skilled and trained staff,

* profitable existing relationships with suppliers and vendors.

In other words, there may be a huge advantage to get into business without having to start from scratch. That advantage is something many business-buyers will pay for.

When starting the new company, we have to account for the entire purchase price. Example:

Buy a company for $100,000.

Inventory is worth $50,000. Equipment is worth $30,000.

You are willing to pay an extra $20,000 not to have to start from scratch, to get the advantage of reputation, workforce and business relationships. Your starting entry will be something like this:

Inventory $50,000

Equipment $30,000

Capital $100,000

You start out 'out-of-balance' unless you also account for the reputation/ work force/ relationships you bought. We call that 'Goodwill'. And now it balances:

Inventory $50,000

Equipment $30,000

Goodwill $20,000

Capital $100,000

Goodwill is shown in 'Other Assets' on the Balance Sheet. When you see 'Goodwill' you know the business has changed hands. Goodwill is handled differently in different countries.