The simplest way to describe goodwill is as a company’s reputation. Say there were two supermarkets with the same market capitalisation, but one of them was more popular than the other, had more experienced management and was in a better location – that one would be seen as more valuable because of goodwill.
Goodwill is an intangible asset, but still appears on balance sheets. So if company X has assets of £2m, but is bought by company Y for £3m, the extra £1m is largely the goodwill – the price paid for company X’s reputation, trading connections, market positioning, profit-earning potential, and so on. It appears on company Y’s balance sheet as an intangible asset (along with patents and trademarks).
• Watch Tim Bennett’s video tutorial: What is goodwill?