What is a business worth?

You need to realise that the balance sheet valuation of assets is no reliable guide to the 'true value' [in non-accounting terminology] of a business. Except on a forced sale, current assets should not be worth less than their balance sheet value - although of course they may be worth more. Fixed assets may be worth more or less than their balance sheet value, depending upon the interplay of the forces of obsolescence, changing money values and market trends.

An up-to-date value may of course be obtained by professional valuation of both fixed and current assets but this is a value of the business assets only, not the business.

The true value of any commodity is whatever a willing buyer is prepared to pay. There are two types of goodwill ;
 
        Inherent goodwill which is an estimate of the qualities referred to above, and
        Purchased goodwill which is the surplus over the fair value of the net assets which
               someone is prepared to pay for the business.
The only type which can be accounted for on the Balance Sheet is Purchased goodwill.

Goodwill is an intangible fixed asset, as apposed to normal fixed assets which are tangible [such as motor vehicles and so on] A business may be worth much more than the value of its tangible assets due to
    valuable business contacts,
    market outlets,
    production facilities,
    geographical location,
    reputation of business or product,
    exclusive or monopoly rights,
    site development potential
to mention but a few. How much are you willing to pay for this business - how badly do you want it? The amount you are willing to pay for these intangible attributes is termed goodwill. 

Consider the following balance sheet of a business:
                £                                     £
Capital 1,000     Fixed assets     800
              ____     Current assets 200
            £1,000                         £1,000

For reasons known only to myself I am willing to pay £1,500 for this business compared to the balance sheet value of its net assets of £1,000. I am therefore, paying £500 for goodwill. Having raised capital of £1,500 with which to purchase the business, my opening balance sheet will appear as follows:

                  £                                     £
Capital     1,500     Goodwill           500 
                               Fixed assets    800
                 ____     Current assets 200 
               £1,500                         £1,500 

It is not uncommon for an item of goodwill to appear amongst the assets in a balance sheet but the inclusion of goodwill does not invest the balance sheet with any greater ability to reflect a true commercial value of the business. Goodwill itself may be valuable one day and worthless the next depending upon the presence or absence of a willing buyer or buyers.



 return to definitions