If a business has goodwill it means that the value of the business as a going concern is grater than the value of its separate tangible assets.
Goodwill is crated by good relationships between a business and its customers, for example:
- By building up a reputation for high quality products or high standards of service.
- By responding promptly and helpfully to queries and complaints from customers.
- Through the personality of the staff and their attitudes to customers.
The value of goodwill to a business might be extremely significant. However, goodwill is not usually valued in the accounts of a business at all, and we should not normally expect to find an amount for goodwill in its balance sheet.
On reflection, this omission of goodwill from the accounts of a business might be easy to understand.
- The goodwill is inherent in the business but it has not been paid for, and it does not have an “objective” value. We can guess at what such goodwill is worth, but such guesswork would be matter of individual opinion, and not based on hard facts.
- Goodwill changes from day to day. One act of bad customer relations might damage goodwill and one act of good relations might improve it. Staff with a favorable personality might retire or leave to find another job, etc. Since goodwill is continually changing in value, it cannot realistically be recorded in the accounts of the business.
Purchase of goodwill
There is one exception to the general rule that goodwill has no objective valuation. This is when a business sold. People wishing to set up in business have choice of how to do it they can either buy their own fixed assets and stock and set up their business from scratch, or they can buy up an existing business from a proprietor willing to sell it.
When a buyer purchases an existing business, he will have to purchase not only its fixed assets and stocks but also the goodwill of the business.