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Very Serious Concerns About Goodwill Upon Balance Sheets

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Well, actually, given that this is from a friend of Richard Murphy – likely the guy who got him the Visiting Professor gig at Sheffield – this is not very serious concerns. This is capitalism bad, accounting is worse mumbling.

The unlikely ticking time bomb on corporate balance sheets
Added up, company debts have ballooned during the pandemic, but it is another calculation altogether that should keep bosses awake at night

That’s goodwill that is. Terrible stuff.

The value of many assets, on the other hand, is little more than a collection of best guesses. For none is this more true than goodwill, which Adam Leaver, a professor of accounting and society at the University of Sheffield, describes as “the shadow asset of the corporate debt bubble”.

Nearly 38pc of S&P 500 firms and 41pc of Eurostoxx 600 firms entered the pandemic with the value of the goodwill on their balance sheet exceeding their retained earnings.

Well, yes, much of modern capital is goodwill and other such intangibles. Apple makes more profit than the rest of the phone market put together because, well, Apple adds a premium to the stuff that’s made. There’s little to McDonald’s other than the actual brand. Intangibles, goodwill, brads, they’re important in modern capitalism.

Were these firms forced to fully write off these highly speculative, intangible assets, it would eat into their equity, placing them in very real danger of going bust.

Well, why might they need to write them off? Because they’re not making money out of them any more. The same would be true of a blast furnace. If it’s not making money then it’s not an asset. B ut do you go bust because you’ve got to write the blast furnace off on the books? Or because you don’t have positive cashflow from owning a blast furnace?

It’s the second, obviously. Why might McDonald’s have to write off the brand? It’s possible – happened to Ratners (not Rayners, see comment) after all – that slapping Ronald across a piece of beef and bread reduces the value of the burger to below the production cost. McDonald’s brand is thus worth less than nothing. But McDonald’s doesn’t;t go bust because they’ve had to write down the brand, they do so because the cashflow from the brand is negative. That is, it’s not the accounting that matters here.

All of which makes Lever a good partner for Murphy. Entirely missing the point and using an identity to explore causal relationships in the wrong direction.

“The big question is how difficult it’s going to be for some companies to sustain the cashflow expectations that underpin the assumptions on which that goodwill is valued in this new world,” says Prof Leaver.

Yes, quite, it’s the cash that matters, not the balance sheet valuation of the goodwill.

What is goodwill? Ultimately it is simply the result of a sum. When one company buys another, goodwill is the difference between the appraised value of the target’s assets, minus any assumed liabilities. It’s basically an accounting ruse to deal with a bid premium without the balance sheet becoming unbalanced.

It’s necessary because there are all sorts of reasons why you may pay more than the book price for a corporate asset. The question that accountants have long wrestled with is what should be done with goodwill thereafter. It’s not really an asset: you can’t sell it and it’s worth the square root of chuff all in a liquidation.

That’s just idiocy. We’ve just defined goodwill as the value that has been bought. Then we’ve said that goodwill is a thing that cannot be sold. Piffle.

“For acquisitive companies with levered balance sheets, [it] could get very messy if all of a sudden observers begin to question the cashflow expectations that underlie their goodwill valuations,” says Prof Leaver.

Again, nowt to do with the goodwill, to do with the cashflow.

If we can make less cash from the ownership of an asset then the value of the asset falls. Yes, and?

But, you know, abolish modern capitalism and bring in summat else. You know, well, summat. Very Murphyesque.

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3 COMMENTS

  1. Nit pick: Ratners, not Rayners. A prime example of if making money selling tat, don’t rub the punters’ noses in the fact it’s tat.

  2. It’s also why there’s a perpetual fistfight for control of the Labour Party. All groupiscles know the sole value of the Labour Party is the name – the brand – and all fight to own that brand to gather in the votes of people who vote for the brand. Any threats to split from the Labour Party are threats to go away and lose access to that brand. See SDP, etc.

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