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I was reading the 10QSB of TrimFast Group at FreeEdgar <a href=http://www.freeedgar.com/search/ViewFilings.asp?CIK=1089297&Directory=1092306&Year=00&SECIndex=213&Extension=.tst&PathFlag=0&TextFileSize=77081&SFType=&SDFiled=&DateFiled=11/14/2000&SourcePage=FilingsResults&UseFrame=1&OEMSource=&FormType=10QSB&CompanyName=TRIMFAST+GROUP+INC target=new>10QSB of TrimFast Group at FreeEdgar</a>

I noticed as an asset they showed "Goodwill - Net", and it increased from about $50k to about $2300k in one quarter. What the heck is that I wondered?

As near as I can tell, it is the amount by which their liabilities exceed their REAL assets. That is, they are underwater, but since they have to make their assets equal their liabilities, they need a line item to show how far underwater they are, and that line item they are calling "Goodwill."

If I am right it is a pretty remarkable newspeak kind of coinage as far as I am concerned.

Anyway, I was hoping somebody here who actually new something might comment on my interpretation.

BTW, I checked the FAQ for this board which does not mention Goodwill, and I checked the fool background info which talked about what Goodwill is only in the context of a merger or acquisition. But the fool info on assets didn't offer "goodwill" as an option, and indeed the fool glossary did not include an entry for goodwill.

TO the moon,
Ralph
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I'm sorry I should have waited before posting. TrimFast bought at least two companies, accounted them under purchase method, and these were the sources of the big Goodwill increase as an asset on their balance sheet.

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I did a cursory look at Trim-Fast.

They purchased Nutrition Clubstores and Max Muscle.

Goodwill arises when one pays more than Net Asset Value (roughly Book Value - but with adjustments) to acquire a company and the Purchase Method is used to account for this.

Ryan

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At the risk of showing my ignorance: When goodwill is amortized ( removing it from the books)doesn't this result in a reduction of net income? And isn't this reduction a "paper event", a non-cash transfer? Or have I developed a need to re-check some books?

Additionally, is there a (fairly simple) way to determine how much above adjusted book value was involved in a pooling of interests? I feel it would be essential knowledge for me to determine whether management made a good deal or not.

Thanks

Bruce
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herd-

"When goodwill is amortized ( removing it from the books)doesn't this result in a reduction of net income? And isn't this reduction a "paper event", a non-cash transfer?"

Yes and yes. This is why companies report EBITDA, or earnings before interest, taxes, depreciation, and amortization. This gives a better understanding of the core business earnings. Also, on the cash flow statement, you'll notice that amortization is added back to net income to arrive at operating cash flow.

"Additionally, is there a (fairly simple) way to determine how much above adjusted book value was involved in a pooling of interests?"

Sadly, there isn't. This is the major criticism with the pooling method, and a reason why the FASB is considering eliminating it. Also, if the merger is accounted for under pooling, you don't have the future reduction of net income from amortization of goodwill. This makes it difficult to compare different companies that use the different accounting methods.

RG
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Hi Bruce,

This is how I see it. Knowing full well that others disagree.

From an operational point of view one should completely disregard goodwill. This also helps when comparing companies.

But from a total management point of view (i.e. how good is management at allocating capital) one should compute ROA (and other such metrics) with goodwill factored in as invested capital. But still remove the I/S charge.

Also, one can approximate goodwill in a pooling. Adjusting book value to net asset value would be tough. But one could assign the amount above book value to "goodwill" to approximate capital commited to the purchase.

Ryan
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Dear Ryan,

I agree with you for the most part.

It's just that in the case of companies which do a lot of acquisitions (e.g. Cisco) I think that something like goodwill is very important. I don't know how much capital Cisco has invested over the past several years, but it is a lot! I think you're right about the amortization charge though...

To put it another way, is acquisition part of a company's operations? In the case of Berkshire, the answer is definitely "yes". In the case of Cisco or GE, the answer is probably "yes".

Incidentally, I'm still not sure how best to think of the goodwill created when say JDSU acquired SDL. The share price of both has dropped a lot, so perhaps the
value of the goodwill on the books isn't indicative. OTOH, perhaps it is, since certainly JDSU could have issued a bunch of shares for cash, and bought SDL for cash.

Best,

Lleweilun Smith
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Thanks RugbyGuy07, your reply was helpful in my endeavor to integrate all the new factoids loose in my brain.

Ryan, you did good too, except for "I/S" which left me feeling "gob-smacked".

Incidentally, I'm still not sure how best to think of the goodwill created when say JDSU acquired SDL. The share price of both has dropped a lot, so perhaps the
value of the goodwill on the books isn't indicative. OTOH, perhaps it is, since certainly JDSU could have issued a bunch of shares for cash, and bought SDL for cash.
JMLS, I may not understand the point you are making here. I didn't think stock price was (short term) indicative of anything related to management or operations success. Can you make a simple explaination to bring me on board?

Thanks all

Bruce

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Dear herd,

JMLS, I may not understand the point you are making here. I didn't think stock price was (short term) indicative of anything related to management or operations success. Can you make a simple explaination to bring me on board?

The quoted stock price each day indicates how much the market will pay for a piece of a company, in cash. JDSU made its purchase of SDL for stock. The point is that it is often said that the value of the shares on the day of purchase doesn't represent true invested capital; but purchasing a company with stock is equivalent to selling shares at the current market price, then buying the other company with cash. We would consider a cash purchase to be true invested capital.

While the stock price doesn't necessarily reflect management or operating success, a high stock price does help acquisitive companies. Issuing stock for purchases is real capital invested (even if it isn't cash); we need to reflect this somehow.

Best,

Lleweilun Smith
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Thank you jmls, that did it for me.

Bruce
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-- The quoted stock price each day indicates how much the market will pay for a piece of a company, in cash. --

Isn't this fact almost another 'goodwill' over and above everything else on the balance sheet equity (including goodwill proper).

This stated, the overvaluing a stock due to let's say - unnecessary exuberance in a particular sector - results in an ensuing reduction in the stock price after investors get the reality check.

Wouldn't a reality check in a sector create big doubts in big chunks of goodwill that may be the result of companies purchased during the exuberant phase of a sector development? Take WCOM for instance. 46B out of 55B equity is goodwill. No wonder their price/book is less than one.

Does anyone track the total goodwill outstanding in a group of companies or within a sector as a measure of how overvalued or speculative a particular industry may be?

Thanks,
Tate
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Dear Tate,

I don't know about tracking goodwill in an industry.

I do think though that the amount of goodwill on the books is nothing more than a measure of (previously) invested capital. Goodwill doesn't represent capital you can borrow against, for example.

Buffett describes book value and intrinsic value as analogous to the cost and value of a college education. Let's ignore the non-economic benefits of a college education, just consider the salary benefits gained from going to college. If you could value your future career salary gains due to the college education, they may or may not exceed the cost of college. The "cost of college" represents the book value; the resultant salary gains represent the intrinsic value. It may turn out that the intrinsic value is properly above book value; it may turn out it is not.

Best,

Lleweilun Smith
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