Goodwill is the value of a business above the fair market value of its tangible assets. It is an “intangible” value meaning that it cannot be directly measured. We can measure the total value of a business in a number of ways. Main street business brokers typically use a multiple of earnings approach with relies on market data to put a value on the business. In other words we are able to value a business based on what similar businesses have sold for.
We can also estimate the value of the fixed or tangible assets of the business. Assets such furniture, fixtures and equipment can be appraised at fair market value. Once we have these two values we can determine the proportion of business value which can be assigned to goodwill utilizing the following formula.
Goodwill = Total value of business – fair market value of its tangible assets.
In the event that the fair market value of the business’s tangible assets is greater than the total value of the business there is no goodwill. In this event the business will typically be sold off for the value of its assets and no more.
In summation goodwill can be thought of as the result of the synergy between various different components of the business that create a surplus value. It is the value of a business’s customer base, reputation, branding, employee relations and any proprietary technology or patents.