Connaught-Goodwill Question

[bullboy8]

In light of events at Connaught, I was wondering if anyone can explain what exactly goodwill is. My understanding so far is that it ONLY appears on the acquiring company’s Balance sheet. What it paid over the net assets of the target company.

However, how about the earnings multiply you normally put on a business, say 5x. So if a company had net assets of £10m and earnings of £1m, an earnings multiply of 5x gives me £5m for the earnings and £10m for the net assets = £15m business worth.



So, in this case, would £5m be allocated to assets (goodwill) on the acquiring company?

 

[scose-no-doubt]

Goodwill on the acquiring company's SFP will just be the difference between what is paid for the company and the value of the company as per whatever valuation method used.
The treatment on the SFP (and possibly consolidated SFP) is entirely dependant on how much of the company is bought %wise.
In your case with the earnings multiplier, internally generated Goodwill is never included in the SFP. That extra value is not realised until the business is purchased and then it will appear on the acquiring company's SFP and only if they actually pay the 15m if the company is valued by net assets alone @ 10m.

 

[bullboy8]

Thanks Scose.

So if the valuations I used is £15m and actually bought it for £18m, £3m goodwill will appear on my balance sheet? You stated that is it the difference between what I paid and the value of the company as per whatever valuation method used (in this case £15m)

I'm not sure what is SFP?

Also, Why would I pay £18m for a company I value at £15m

Thanks

 

[scose-no-doubt]

SFP = Statement of Financial Position = New Balance Sheet under IFRS

As for why you pay over the odds, maybe the company you're buying doesn't agree with the valuation used. Maybe the income stream is valued at more than the assets. Maybe the company has a good reputation. Growth potential? Could be a million reasons

 

[bullboy8]

Thanks Scose

So the £3m will be on my SFP as goodwill?

I'm still struggling to understand why you would pay more than £15m if your valuation is £15m. I understand the reasons behind your explanation but surely if I value the company at £15m I would have factors in good reputation, gowth potential, and all other reasons. so £15m is the most I would pay. Anything less is considered a bargain. That is how I have valued shares. I would never pay more than what I value a company.

 

[scose-no-doubt]

Not saying you would pay more than a valuation I was just saying you can get a lot of different types of valuation that will give different results. NPV of future cash flows is the most common valuation method I think and that is can of worms territory.
It's really not simple stuff. Why do you think those M&A types get paid so much?