Should intellectual capital be made a part of a company’s balance sheet.
Published by manish August 30th, 2006 in My Best Posts.[Originally posted on May 17 2006]
As I picked up my copy of the economic times on last Sunday , I came across this article.The process of valuating people based on what they would earn until they retire as mentioned in this article is something I find really shallow and ignorant of the value people bring for what they earn.
This is taking the cue from something I had drafted on the 13th of December 2004; however I could not publish it. So I dug into my archive and here it is.
With the boom being witnessed in the knowledge based industry, mainly companies in the IT, Software and pharmaceutical sectors, a new economic syndrome has come into the fray, that of the knowledge economy. Intellectual capital (I-Capital) forms the only tangible asset of this economy.
Even today, valuations of companies do not include I-Capital as one of the assets which can be showcased on the balance sheet, even though that may be the only asset the companies have. So now comes the big question,” How far can companies ignore their I-Capital and treat it like an asset which cannot be measured?”
On hindsight measuring the I-Capital can be of great benefit to the top management because it gives an indication to the effectiveness and efficiency of the intangibles. Hence this is where knowledge management (KM) becomes such a critical function. So every document, every slide, every case study, every code asset constitutes value and KM ensures that I-capital is owned by the company even if the people take off elsewhere.
Moreover companies which are take over targets by the big daddy’s of the knowledge based industry can enhance their valuations based on measurement of this asset. For instance if WIPRO was a take over target by an EDS or an Accenture tomorrow and they valued their I-capital too, their valuations would be much above their 2004-05 revenue figure of $1.6 Billion. Hence this may thwart the bids of the companies trying to take them over.
So probably going forward we could see company valuations showcase the I-capital in the balance sheet. I can already hear the finance minister licking his lips and looking at taxing these I-capital assets. Hmm..just another thought!!
the new site looks good!
Of course compnaies to have IC on their balance sheets, if you buy a brand you can capitalise it on the balance sheet.
Note that capitalising an item on the balance sheet reduces your tax liabilities and that is why the tax may gnerally does not allow it if you are generating the IC assets yourself - but they do allow it when you have acquired i.e. paid for them.
Interestingly there are examples - and I won’t defame any individuals, where there IC has been on the balance sheet through transfer costs and they do something where their value got from $ms to zero - so having all your IC on the balance sheet can cause embarassement - particulalry with shareholders - so not surprisingly it is cautiously managed by all.
I would suggest that if you were Bill Gates or Warren Buffet you never capitalised your IC - this is because the cash flows that it generates going forward and converted back to the present value tell you more about your IC than you want other people to know! Microsoft for example has contracts into the future from which it draws revenues and these are what make a business succesful not wether it capitalises IC on the blanace sheet.
If Microsoft was to sell its brand image imagine how much that would be worth and yet as it was developed by the compoany out of revenues it can’t be capitalised on the balance sheet.
I have tried to find an example of a seriously successful company which has IC capitalised on its balance sheet and not found one yet. This leads me to beleive that you don’t invest in companies who have balance sheet IC - i.e. they bought it of someone else but you invest in companies that generate IC - and because they generated it themselves they can use it to better effect than that which is translated acquired etc. Interesting there is a parallel here with technology licences - would you invest in the company who invented the technology and are developing it or a company that bought a licence? The licence is IC but they are borrowing it - it doesn’t mean they won’t make money but unless they raise their IC capacity they can not develop the technology and merely continue to buy from the leader.
So in conclusion I can not get excitied Knowledge economy or no about whether regimes decide to capitalise IC or not - having it adds value to business and certainly raises competitiveness - far more important than what the accountants do with it!!