Wednesday, June 11, 2014

Value in goodwill

Yesterday I enjoyed a conversation with a cousin of mine.  This cousin made a point which provides an example for my Wealth in Institutions thesis.

My cousin has a business as a licensed professional structural engineer.  He told how most of his work comes from architects with whom he has worked before.  He has learned how to work with these architects, and they with him.  When one of these architects gets new work, or the prospect of new work, the architect can communicate with my cousin by using only a few words because they know each other's expectations.  This efficiency of communication between trading partners did not grow overnight.  It has taken over 15 years to develop.

My cousin spoke about the value of a business such as his, that is the price if such a business were to be sold to a buyer.  The value comes almost entirely from the established pattern of trade, from the flow of calls from architects who need help with engineering and who expect to be satisfied with the help they get from this business.  Other assets of the business, such as furniture and computers, have little value in comparison with the value of established trade.

So this provides an example of wealth in institutions.   The wealth is expressed in the value or price of such a business.  The institutions are the established expectations of trading partners.  Most of this wealth is not visible to the untrained eye; it is not tangible.  This wealth exists only in the expectations in the minds of some architects.

When I took the accounting classes required of an MBA student, I learned to think of this kind of wealth as Goodwill.  The balance sheet of a company may show that most of the value of the company exists in this intangible category.  The point I am trying to make with this Wealth in Institutions (WI) thesis is that most of the wealth in a modern capitalist society also exists in such an intangible category, in institutions, that is in expectations and not in physical assets.

On my to-do list, I want to review double-entry bookkeeping to think about the steps leading up to an entry of goodwill.  I hope such study may offer insight which connects our established ways of thinking with the WI thesis.

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