Companies that don’t realize the power of intangible assets and fail to capitalize such assets may miss out on opportunities to increase shareholder returns and gain competitive advantage. The growing disparity between company stock prices and book value per share suggests that a new approach to the valuation of company assets is needed. Management is responsible for effective utilization of all assets under its control, yet probably few companies have a good understanding of the value of intangible assets which they own. The books of accounting treat tangible assets in detail, but provide only limited information about intangible assets, although these may represent the greatest value for the company and the greatest source of potential growth and profits.
Generally, finance managers think that tangible assets determine a company’s value. Such tangible assets could be plant and machinery, equipment, land and buildings and inventory. They were assets that determined a company’s value, assets that could be measured and used to calculate return on investment. Those assets were solid, and so were the financial decisions based on their value. But in the world of finance today, things aren’t what they used to be. In the present economy, the most valuable assets have changed from solid to soft and from tangible to intangible. Instead of plant and machinery, companies today compete on ideas and relationships.
Intangible assets are the non-physical assets of the company and cannot be measured in conventional accounting terms. Such assets that impact on a company’s value can be categorized as brand equity, customers, copyrights, human resources, reputation of the company, and research and development made by the company.
The creation and maintenance of brands are becoming more and more important in today’s intensely competitive environment. A strong brand can be a valuable asset for a company. Through the branding process executives and brand managers intend to create recognition and change purchase behavior among their customers. Branding is often related to a product; however, in the mind of the consumer there is no difference between the product and the company. Positive and negative actions by the company carry over to the perception of the product and vice versa.
Accounting of Intangible Assets
Limitations of accounting
One of the major problems with today’s accounting systems is, that they are still based on the current transactions, such as expenses incurred on the purchase of goods or income realized from the sale of goods. In the current, knowledge-based economy much of the value creation may take years after the occurrence of transactions. The successful development of a product, for example, creates considerable value, but actual transactions, such as sales, may take years to materialize. Until then, the accounting system does not register any value created in contrast to the investments made into research and development, which are fully expensed. This difference, between how the accounting system is handling, or better not handling, value created and is handling investments into value creation, is the major reason for the growing disconnect between market values and financial information.
The interesting thing with knowledge based intangible assets and a knowledge-based product is that they behave differently from traditional industrial products and tangible assets from an economic point of view. For example, the economic law of diminishing returns, which applies to tangible assets-based business, does not apply to knowledge-based businesses. The main reason is the lack of scarcity of knowledge-based assets. In contrary, scarcity is a typical characteristic of tangible assets.
Another difference between a physical assets-based company and an enterprise, which is based on intangible assets, is that the latter is more difficult to manage. This is because that intangible asset represents only a potential value and only through a strategic management system like the balanced scorecard, a company is able to transform this potential into tangible financial value.
Relationship with tangible assets
There is not a direct one-to-one relationship between an intangible asset, like the knowledge of a worker, and a financial outcome. For example, if a company sends its workers to training programs for one year, this will not show immediate result into increased sales revenue. Instead we have to understand the case that training will improve something like quality, and if quality will improve, customer confidence will improve, and if customer confidence improves, then they will buy more, and the sales of the company will go up in future.
Enhancing Intangible Assets
In today’s slow-growth economy and stagnant capital markets more attention to corporate resource allocation is required from managers. So, managers should develop the capability to assess the expected return on investment in research and development, employee training, information technology, brand enhancement, and other intangibles and compare these returns with those of physical investment in an effort to achieve optimal allocation of corporate resources. Today, most business enterprises do not have the information and monitoring tools required for the effective management of intangibles. Therefore, investing in these new types of management systems may become important tasks especially during an economy slowdown.
Enhancing Shareholder Value
Intangible assets increasingly drive shareholder value. In order to effectively allocate capital, the finance manager must be able to measure and manage the intangible assets of their companies. Tools to help the finance manager in this fast-changing area are still to be developed. While managing the intangible assets, the focus should be towards building a comprehensive view of both the tangible and intangible assets and managing relationships among them in order to maximize shareholder value.
We cannot isolate the value of a single intangible asset like knowledge. We have to combine several intangible assets to achieve a result. It is impossible for a financial system to describe this process of value creation. Financial systems are always snapshots: they can’t describe a time-based logic of cause and effect. They look at wages paid to labors as one category, inventory as another and do not show the cause effect relationship between these two variables.
Finance managers should always realize the need for managing intangible assets, not only at the time of a crisis. As competition intensifies, monitoring intangible assets will become a focal point for the financial management. Therefore, they should realize that intangible assets are untapped source, which could be leveraged for competitive advantage.