Realizing the strategic value of goodwill impairment valuations

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

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.