Definition
The term goodwill to assets refers to a ratio used by analysts to estimate the impact the intangible asset goodwill has on a company's balance sheet. SFAS No. 142 instructs companies to write off goodwill as it becomes impaired. Without a need to amortize goodwill over time, it's important for the investor-analyst to understand the affect goodwill has on assets, and whether or not this value is rising or falling over time.
Calculation
Goodwill to Assets Ratio = Unamortized Goodwill / Total Assets
Explanation
At one time, accounting rules in the United States required companies to amortize intangible assets like goodwill over a period not to exceed forty years. Back in June of 2001, the Financial Accounting Standards Board ended automatic amortization of goodwill, and now allows companies to measure it annually to determine if there is an impairment loss.
For this reason, the investor-analyst needs to be cognizant of the additional flexibility SFAS No. 142 provides companies and how this ruling can impact assets appearing on the balance sheet. The goodwill to assets ratio provides insights into the proportion of the company's total assets that are made up of an intangible asset.
Unfortunately, the ratio alone does not tell the investor-analyst anything about the quality of the company's goodwill. Additional research is needed to determine if impairment, and a subsequent write down of value, will occur in the near term.
Example
Company A's mergers and acquisitions group seized the opportunity to purchase several of Company A's smaller competitors. The premiums paid as part of each deal result in the relatively high levels of goodwill shown in the table below.
Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
Goodwill | $1,607,000 | $3,470,000 | $3,633,000 | $6,293,000 | $6,845,000 |
Total Assets | $12,175,300 | $13,993,000 | $15,392,000 | $17,431,000 | $19,174,000 |
Goodwill to Assets Ratio | 13.2% | 24.8% | 23.6% | 36.1% | 35.7% |
While Company A's total assets grew by nearly 160% over this four year timeframe, goodwill grew over 400%. The goodwill to assets ratio also raised a warning flag for the investor-analyst since this intangible asset now makes up over 35% of the company's total assets.
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