06 Dec. 2019 | Comments (0)
Brand is one of the paramount drivers of enterprise value. But in today’s economy, brand alone is too narrow a concept to cover the big corporate value picture.
Instead, I offer a Theory of Intangible Capital, a conceptual framework that includes brand as well as other internally grown unaccounted assets that don’t appear on the balance sheet but are reliable drivers of corporate value.Intangible capital is about understanding how intangible assets that you manage fit into the big picture of the total market value of the company. Employees across the board may be surprised at how important of a role their intangible contributions play in creating value.
Today, internally grown intangible assets are not on corporate balance sheets and are only examined for their value when one company acquires another. But not only does the value of intangible assets in a merger depend on the type of intangible. Each one is evaluated independently, isolated in a silo from the others. For example, marketing is evaluated independently from customer-related intangibles, which are evaluated independently from technology.
This may be necessary when a company is bought or sold, but it doesn’t help the manager when the company is running at pace. The theory of intangible capital aims to provide a tool to help keep managers accountable for the costs and benefits of growing their intangibles.
Consider spending on intangible assets created by R&D. Depending on the company and industry, research can be a very high investment. How is the return on that investment measured? Like an investment in brand marketing, the cost of R&D is listed on the financials as an expense rather than as an investment in the future revenue-generating capability of the company. The primary reason they are considered expenses and not investments is the tax advantage they embody when expensed. But there is a strong argument for making investments in brands, and research is a capital investment if these costs are expected to generate future return.
Training is another expense that has significant ramifications for future growth and productivity. Some training directly impacts customer satisfaction. Is training your employees to better serve your customers an investment that will generate future returns? How is the return on training investments accounted? How are budgets determined for training? Is enough being spent on training programs to provide a return on the investment? If internally grown intangibles, which help answer such questions, are not on the balance sheet, how will management and investors know if the investments are well spent?
A company that promotes innovation at all levels develops a culture of innovation and that, in turn, creates a premium value opportunity for both its products and its stock value as recognized by the cash flow multiple. You won’t find a “culture of innovation” line-item on the balance sheet either, but it is a component of the price that investors are willing to pay for owning shares of a company.
How budgets are established and accounted for in corporations is another consideration. Branding, marketing, advertising, media relations, and public relations, for example, are all tools critical to corporate success, but when companies only count them as expenses, they deprive themselves of the ability to gauge the impact these assets have on corporate valuation. This lack of accountability or method for calculating a simple ROI for intangible assets forces the chief marketing officer, human relations manager, research scientists, marketing managers, and public relations managers to build budgets based on things other than value creation. Further, it forces investors to guess the impact intangible capital programs will have on the corporate value, inadvertently hiding material intelligence from the public.
In summary, what these internally-grown intangible assets have in common is that they are all accounted as corporate expenses, but are not evaluated for the value they create, resulting in a lack of transparency for investors and management. It is unlikely that the accounting system behind it, known as GAAP (for Generally Accepted Accounting Principles), will change any time soon. But even without such a change, all these intangible assets can be measured, valued, and managed consistently and reliably. As material financial insights into the company’s operations, they should be consistently disclosed in the notes portion of annual reports along with the methodology of how the values were derived.
This is not unheard of: Two common intangible assets that can already be found in the notes of many annual reports relate to patents and trademarks owned by the company. The key to any adding notes to annual reports is the value has to be calculated and reported uniformly. The theory of intangible capital calls for quantitatively measuring all of the intangible assets, as is possible with descriptive attributes. These quantitative measures, along with key financial data, become independent variables against the cash flow multiple, which is the dependent variable in a consistent model for measuring, valuing, and managing intangible assets.
By taking a holistic perspective and working with the managers of other intangible assets, it is possible to measure and evaluate the impact of all intangible assets on the value of the company. There is nothing wrong with being focused on the brand, but it is important to see the brand as part of a much larger intangible asset ecosystem. As a result, intangible capital is not only a better system for establishing budgets, but also a method for evaluating the corporate value impact of your efforts.
See author James Gregory share more insights at The Conference Board’s Innovation Metrics & Culture Summit, held December 10-11 in New York City.
This post is the fourth in a series on intangible assets. Check out past posts below:
- Making Intangibles Tangible: Who is to Blame When Brands are Written Down?
- Making Intangibles Tangible: The Benefits of Measuring Intangible Assets
- Making Intangibles Tangible: Not Including Intangible Assets in Financial Statements Can Lead to Consequences