Forum Archive Index - November 2000

[Brian Gale <brigale@i4free.co.nz>]

Thanks for that Warner. One or two comments.

Negative side
Most often Goodwill can be related to a companies future earnings
i.e. the purchaser is paying for earnings which have not yet been
received.
 
The goodwill shows on the balance sheet as an intangible asset with the
other side of the equation being either an increase in capital or a
reduction in cash (depending how the deal was struck)
If it is an increase in capital, of course this affects the earnings/sh.
funds ratio adversely.

Being an intangible asset (as was discussed earlier on Sharechat) any
write off is not tax deductible.

And it is not included in the NTA of the company.

There is no set formulae for amortization of Goodwill, it is determined
by the Directors. In your example 40 years is quoted but I believe 10
years is a more common period (This could well be a recommendation by the
Society of Accountants)  I am no expert on this but I suppose the
Goodwill could sit on the balance sheet indefinitely but it is desirable
to reduce/remove it  as although it is on the asset side of the
balance sheet it is more like a liability. In other words the purchasing
company have paid for something they have not yet received, but hope to
receive with a bonus added, in process of time.

Positive side 

Cash flow is the overriding factor.  Goodwill will only be
paid for a operational company with a proven trading performance. That
cash flow is of course the key to the continuing operation of the
enterprise and if the process of amalgamation allows for reductions in
expenses the resulting profit will be better than anticipated and
therefore a gain on the amount included in the Goodwill.

As an example:-  Suppose $1000 had been paid for Goodwill. 
After a years trading if the profit (after tax) was $1500 the Goodwill
could be written off leaving a final profit of $500

However there have been many examples of take -overs where this expected
improvement has not taken place and the end result has been a worst
result for the company doing the take over.  Usually where the
purchaser got into a new type of operation without the necessary
expertise, but with the rather conceited idea that doing well in one
particular field automatically qualified them to do well in a totally
different field. 

Inflation is mentioned in your quotation and this would certainly be a
positive where high Inflation was prevalent but in current low inflation
conditions not so advantageous.  The theory here being that the
goodwill was based on expectations at a  point in time,  but as
time progressed prices could have been adjusted for inflation. 
However expenses could also have increased.

Summary

I think where Goodwill becomes a problem is where it is large in
comparison to NTA. e.g. ADV and 
RMG.  Sooner or later it has to be offset against earnings to give a
true picture of the company's performance.

Regards
Brian

At 17:20 17-11-00 +1300, you wrote:
> Brian, this is very long but I
> thought it was very interesting and a clear
> view on Goodwill and Amortization from Buffett. Goodwill is not the
> precieved evil paid for intangable assets but acording to him can be
> a
> blessing. etc.............................