Goodwill to Assets

Ratio
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The goodwill to assets ratio is a financial measurement that compares the

intangible assets like a brand name, customer list, or unique position in an
industry to the total assets of the company in an effect to see if goodwill is
being recorded properly.

Definition – What is the Goodwill to Assets

Ratio?
Goodwill is synonymous with reputation and in business that can be a huge
asset for a company. The accounting term goodwill gives a way for companies
to value their reputation in a monetary form. Though it’s important and can
carry significant value, goodwill needs to be compared to other assets when
determining a company’s value.
This is where the goodwill to assets ratio comes into play. It’s a measurement
that shows the relationship between a company’s definitive assets and the
power of its namesake. The higher the ratio, the higher the value of the
company’s goodwill vs actual assets.
U.S. GAAP and IFRS accounting rules have given management the sole
responsibility for tracking and valuing goodwill. Therefore, investors, creditors,
and the company’s own management should carefully review asset valuations
and distinguish between non-monetary items like client relationships and
brand reputation and tangible assets, such as property, machinery and
equipment. Giving too much value to brand name or reputation may skew the
true financial picture and hide potential problems.
Let’s take a look at how to calculate the goodwill to assets ratio.
Formula
The goodwill to assets ratio formula is calculated by dividing total assets by
the total goodwill found on the company’s balance sheet.

Goodwill to Assets Ratio = Goodwill / Total Assets

The first step in this calculation is finding the goodwill and total asset values in
the financial statements. Total assets should be easy to locate on the balance
sheet. Goodwill can be found in the non-current assets section of the balance
sheet.
Sometimes, goodwill can be tricky to determine but is, essentially, the
difference between all defined assets and the total asset valuation. Do not,
however, confuse goodwill and intangible assets. Though both are intangible,
goodwill is specifically reserved for items that are not typically found on the
balance sheet like reputation and brand awareness.
Companies typically only have goodwill on their balance sheets if they
purchase another company or asset for more than the book value or fair
market value of the company or asset. For instance, if Company B was worth
$10M and Company A bought it for $60M, $10M would be recorded as an
asset purchase and $50M would be recorded as goodwill since this is the
amount of money that Company A attributes to Company B’s non-balance
sheet assets.
This ratio is reflected as a percentage of total assets. In other words, it shows
us what percentage of assets goodwill represents.
Let’s take a look at an example.
Example
Apple, Inc. is world-renowned for its innovative products and fiercely loyal
customers. It’s a brand that needs no introduction because it has incredible
value just in its name. Let’s assume that there was a company big enough to
acquire Apple. It would have to pay way more than the book value of Apple’s
assets because of Apple’s reputation, customers, and industry status. This
extra amount paid over the book value is considered goodwill.
In this hypothetical transaction, assume Apple is asking $900 billion. The
purchaser must determine if this is a fair price and needs to know how much
is being paid for the name alone. The book value, according to Apple’s most
recent balance sheet, amounted to $100 billion. Let’s assume in this case that
there is no debt to be acquired. So, the amount of goodwill being acquired at
this purchase price would be $800 billion. The purchaser uses the following
formula:

Goodwill to Assets Ratio = $800,000,000,000 / $900,000,000,000 = 88.8%

The resulting ratio of 88.8% illustrates that Apple is attributing most of its total
value to its goodwill. In other words, its brand image and reputation are worth
eight times more than its tangible assets. This doesn’t seem logical but can be
the case for certain brands. The potential purchaser will have to review other
pieces of information to determine if the investment is worth the valuation
Apple is currently requesting.
Analysis and Interpretation
The acquiring company in the scenario above should compare this goodwill to
assets ratio with other companies in the industry to see if Apple’s is in line with
others. If in the same industry, the purchaser may also consider the threat of
Apple’s goodwill as a competitor brand in the valuation. For example,
continuing competition with Apple may cost the company more than if it
acquires the brand for its own benefit.
If the purchaser in this scenario went through with the acquisition, it would
then begin reporting that $800 billion of goodwill obtained in the purchase on
its own balance sheet. This will affect the purchasing company’s balance
sheet and its own value.

Usage Explanation – Cautions, and Limitations

Shareholders and investment analysts pay attention to changes in the
goodwill to assets ratio to see how mergers and acquisitions like this affect the
company’s value. For example, a decreasing goodwill to assets ratio may
mean brand image has been marred in some way but could also be caused
by increasing values of other company assets. So, it’s not always a bad sign.
If this ratio continues to decrease as a result of damage to image, reputation
or the like, the company will have to mark down its goodwill through goodwill
impairment. This is made clear on financial statements, so it is easy to
determine if that is the cause.

An increasing goodwill to assets ratio signifies goodwill acquired is outpacing

other asset values. This could be a good thing to a common stock
shareholder, signifying brand growth, but to a bondholder it could look scary,
as the goodwill value is meaningless in the liquidation of a company. It could
also mean that the company is acquiring more companies and over paying for
them. Thus, acquiring little tangible assets and filling the balance sheet with
“not real” assets.
A good example of this is Microsoft’s acquisition of Nokia. A year after the
acquisition, Microsoft wrote off over $4B of goodwill simply because they
realized they overpaid for it and it wasn’t worth that much money.
As with other financial analysis tools, this ratio presents some key information
about the health of a company in a relative sense. Always dig deeper to find
out what may be the underlying cause as to why a company has either a high
or low GTA ratio and how that compares to the other