## How To Calculate Goodwill In M&A Deals And Merger Models

In this tutorial, you’ll learn why Goodwill exists and how to calculate Goodwill in M&A deals and merger models – both simple and more complex/realistic scenarios.

Video length: 00:17:53

Transcript

Hello, and welcome to another tutorial video. As you can see this time round we're going to go over how to calculate goodwill in M&A deals and murder models why it exists and show you a few simple examples of how this works. Now this one does not actually come directly from a reader or watch your question but it comes from the fact that I was looking at this channel the other day and I realized that we had videos on topics like negative goodwill or bargain purchases and also topics like purchase price allocation for non-controlling interests but we don't have anything specifically on a former basic topic which is how to calculate goodwill in the first place. Also even though it's a fairly basic topic we actually get a surprising number of questions about it despite the fact that there's detailed coverage in our guides and courses. There are lots of articles on mine on Investopedia Wikipedia. Other sources like that. It still seems to cause a fair amount of confusion. So here goes our explanation starting with why goodwill exists and a simple example. Once we go through that then we'll look at a slightly more complex example and some added complexities that can come up in this calculation in real life with more advanced models. So why does goodwill exist. The short answer is that goodwill is an accounting construct that exists because it emanates deals buyers almost always pay more than what the sellers balance sheets are worth.

So if you look at roughly assets minus liabilities and say that's the value of a seller's balance sheet to acquire the Sillars equity a buyer is almost always going to pay more than that number. Now the buyer gets all the seller's assets and liabilities. So when this happens when it pays more than what the seller's balance sheet is worth that makes its balance sheet go out of balance. When a deal closes we create goodwill to fix this imbalance and ensure that assets equals liability plus equity on the combined balance sheet. The basic calculation for goodwill is that it equals the equity purchase price and the deal minus the seller's common shareholders equity. That's what goes away in the deal plus the sellers existing goodwill that also goes away. And then you add or subtract other adjustments to the seller's balance sheet. Let's go through a very simple example an excel so you can see what this looks like visually. We're going to say here that a buyer pays a thousand dollars in cash for the seller and the seller has fifteen hundred dollars in assets 600 in liabilities and common shareholders equity of 900. So let's go into excel and see what this looks like. Here is our target company right here. We have cash of 200 accounts receivable 300p.p. of 1000 and so total assets equals 1500. And then on the liability side they have debt of 400 accounts payable of 200 equity of 900 and so liabilities plus equity equals 1500. And our balance sheet for the seller balances.

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