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Realizing the strategic value of goodwill impairment valuations

Goodwill impairment valuations are required for financial reporting standards and can also be valuable for strategic decision-making.


In brief

  • In a recent EY survey, a majority of CFOs said they recognize the strategic value of goodwill impairment valuations. 
  • Goodwill impairment valuations can benefit companies that elevate this annual requirement from a compliance exercise to an input for strategic decision-making.
  • The requirement to test for goodwill impairment (FASB ASC 350) isn’t going away, so companies should take steps to capture more value from the process.

What if you had a trove of fresh valuation data and insights at your fingertips when making decisions about investing in your company’s future? If you’ve completed a goodwill impairment valuation, you are likely sitting on an information gold mine but may not be getting the full benefit.

Goodwill impairment is gaining attention after US regulators recently walked back plans to replace the required testing for impairment with a more straightforward amortization approach. In addition, goodwill impairment valuations may become more frequent in the near term given the recent and expected volatility in the stock market increasing the potential for impairment.

While the Financial Accounting Standards Board’s decision to keep the requirement for goodwill impairment (ASC 350) may not seem like a moment to celebrate for those who approach this task with gritted teeth and a compliance mentality, we have seen that companies that use the process as an input for strategic decision-making can obtain significant competitive value from the exercise.

Goodwill is recorded after an acquisition and reflects the price paid in excess of the identifiable net assets. The impairment charge is the adjustment companies must make if the fair value of a reporting unit falls below the balance sheet value. Under US GAAP, companies are required to test for goodwill impairment at least annually, as well as on an interim basis if there is a triggering event for potential impairment.

Hidden insights from goodwill impairment valuations

Goodwill impairment valuations, which are effectively sum-of-the-parts analyses, can help management: 

  • Hold a strategic conversation about the company’s business portfolio, including deciding which businesses warrant additional investment capital, and which may be candidates for fixing or divesting 
  • Use the required reporting unit valuations, as well as supplementary valuations of segments, divisions and lines of business, to impose good governance on investment decisions 
  • Communicate the company’s capital allocation strategy to leadership and the board
  • Obtain insights provided by a long-range forecast, which may already be available as part of the goodwill valuation but are not being reviewed by strategy and financial decision-makers

Even when there is little or no risk of impairment, we find some companies elect to perform an annual goodwill valuation, instead of the qualitative test, because they have found it a valuable input to fiscal planning. Equity analysts regularly use sum-of-parts valuations in their research because of the insights they provide.

There’s evidence that plenty of organizations understand the value of goodwill impairment valuations. In Strategic Valuations 2022, a recent EY survey of 150 CFOs, respondents said the three most important internal uses for valuations are strategic planning and portfolio analysis (47%), budgeting and long-range forecasting (43%) and capital allocation decisions (37%). [Figure 1]

Goodwill impairment has many uses

In the survey, conducted prior to FASB’s June 2022 decision to keep the goodwill requirement, 64% of respondents said they would continue to perform annual reporting unit valuations for strategic and other purposes even if the rule was changed. Twenty-one percent said they would not do so, and 15% were undecided. The results indicate that many companies see value beyond accounting compliance in the output. [Figure 2]

In our experience, however, companies can get far greater benefits from goodwill valuations than they are currently achieving. Many companies rush through the process and stop when it’s clear they pass the test. In many cases an additional 20% of work can deliver immeasurable new value by unlocking analysis and learnings that would otherwise be overlooked. And companies that do the work internally or perfunctorily may miss the advantage of having an independent perspective of functional domain professionals.

Companies that have recognized the strategic value of goodwill impairment valuations 

Business services company: strategic planning and portfolio analysis

▉ Leaders at a business services client who were interested in doing a portfolio review of their reporting units and capital allocation analysis recognized they could use the goodwill valuation output to get answers without paying to build a strategic analysis model from scratch.

▉ The company decided to conduct a strategic alternative analysis, based on reporting unit scenarios, to help management make improvements, including decisions about capital structure and share buybacks, by quantifying the financial implications of available options.

Biotech: using forecasting to understand the drivers behind growth

▉ A biotech client acquired a non-core technology business that had a software platform designed to improve brand loyalty. Management lacked deep experience with the acquired business and struggled to understand its performance drivers compared to their core business. After the acquisition, the software business became a second reporting unit. 

▉ Executives recognized the need for a driver-based forecast that extended beyond operating income to include free cash flow. The company was able to use the forecast and insights developed for goodwill impairment testing to monitor the performance of their acquisition and build accountability within the organization. The company also was able to use the free cash flow detail to communicate important capital needs and ROI information to the board.

Software: gaining visibility for capital allocation

▉ A leading technology client regularly leverages the goodwill impairment process to support its strategic planning and portfolio analysis across the enterprise. The forecasting process is focused on input from each reporting unit on long-range value drivers and the capital and resources necessary to achieve top-line estimates. Even when there is no question of impairment, the company uses the annual sum-of-the-parts analysis as the basis for its portfolio review and communicates the results to its board.  The valuation is even used by the strategy and finance teams as part of the onboarding process, to familiarize new members with each of their businesses. 

▉ This company’s process brings business unit leaders together with functional leaders in strategy, finance, accounting and the C-suite for insightful value-based discussions that help inform strategic and capital planning decisions. In our experience, this is a leading practice; often too few senior leaders in organizations understand the relative value distribution of the enterprise across businesses. By democratizing this information, companies can align leaders on which businesses drive value for the enterprise and enable them to use this lens when making decisions on capital allocation and resource prioritization.

 

Help from outside 

The EY survey showed that when CFOs use third-party providers to perform valuations, what they find most valuable are technical expertise (58%), market data and perspectives (49%) and the objectivity of an outside provider (38%). Respondents also indicated the biggest challenges they face in preparing valuations are subjectivity of key assumptions (65%), lack of people (58%) and availability of consistent data (56%). [Figure 3]

Companies benefit in different ways from outside advice

A third-party valuation can help address the skills-and-resources gap as well as provide an independent perspective that can help eliminate influence from internal biases or organizational politics. As with the business services company example, an outside advisor can quickly and efficiently build upon the impairment analysis to perform a full portfolio review, evaluate a range of strategic alternatives, perform competitive benchmarking and enhance the analysis in a variety of other ways. An advisor with access to multidisciplinary skills can also bring other needed experience, such as commercial diligence or working capital services, depending on what is needed. Advisors also have experience with collecting required data for valuation inputs, which can be arduous and time consuming because it often resides in different systems and with different constituents within an organization. 

For more resources and technical guidance on accounting for goodwill impairment, see the EY financial reporting developments: Intangibles – goodwill and other.


Summary

Many companies that already must perform an annual goodwill impairment valuation can get more value from the exercise by using the resulting data and insights for strategic, board-level decision making. Valuation analysis can help management with strategic planning, long-range forecasting, capital allocation and communication with investors and the board.



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