Analysts are increasingly focusing on intangible assets when calculating a company's worth. Campbell McCracken reports.
Financial analysts, whose job it is
to advise their clients on whether to buy or sell a company's stock, have always had to try to
account for the difference between the market value (market capitalisation) of a company
and the book value (the value of the assets in the company's financial statement). This has
largely been an unknown quantity. But in recent years, they have started looking more closely
at these intangible assets when evaluating a company.
The inadequacies of traditional balance sheet are well recognised. A 1998 PricewaterhouseCoopers survey of corporate executives found that only 38 per cent found a financial statement very useful in communicating the value of their company. The financial statement doesn't take into account all of the intangible factors that largely determine a company's value and growth prospects.
"Because the analysts have no really good information, they speculate," says Jeanne DiFrancesco, a principal at consulting firm ProOrbis (which has written courses on how to account for intangible assets). "They cause the market to behave in ways that are overly speculative in nature. Mature markets that should be operating with clear information and should be extremely efficient, are instead behaving in a way that is too erratic for the kind of information that should be available. They are behaving more like 'spec' markets than mature markets."
Accounting systems were originally designed for measuring the profit and loss of manufacturing companies. Calculating the cost of manufacturing a widget, and the revenue from selling it, was straightforward. It's not so easy to do the same for a company providing a service, or selling expertise.
Most analysts agree that only by taking the intangible assets into account will the actual worth of the company be better known. It is widely recognised that the investments in R&D, Internet applications, human resources and customer acquisition are driving the performances of companies.
But it's not until these assets are catalogued and valued that their true worth will be known. It is not unknown for a company to be unaware that it has valuable information because it has never been identified. In some cases the intangible assets may not be of much use to the business that developed it, but another firm may find them to be very valuable.
What are intangible assets?
Some examples of intangible assets are
For knowledge based companies, the intangible, or 'unreported', assets are on average several time those of the tangible assets. In CFO magazine's Third Annual Knowledge Capital Scorecard, conducted in 2001, the ratios of market value to book value were 16.3 (Biotech Industry), 15.2 (Computer Software) and 12.2 (Pharmaceuticals). Some individual companies had a very high ratio, for example Oracle at 39.4:1.
How are intangible assets valued?
There's no one recognised method for valuing intangibles. However,
frequently used methods include
"For example, the financial community thinks human capital is impossible to value," says DiFrancesco. "Part of the problem is that they don't define it correctly. If you think that human capital is 'people', which it is not, and you think that people are the asset, then valuation will elude you."
Human capital is the time, energy, talent, enthusiasm, and so on, which people apply to the things that they do. So as far as a company is concerned, its asset is the combined investment that all of its employees make in it. In return, the company gives certain things in exchange, such as salary, compensation, benefits, relocation and training.
"Another problem with the valuation of intangibles is the amount of confusion between the investment in the intangible asset and the value of it," says DiFrancesco. Again, in the case of Human Capital, the value is not the cost of salaries, training, etc, but an amount derived from the value of your contribution to what the company eventually sells. It may have no relation to what the company pays you.