Intellectual Capital
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Understanding corporate value: managing and reporting intellectual capital Intellectual capital Contents 1 Introduction 4 2 Definitions of intellectual capital 6 2.1 Classifications of intellectual capital 2.2 Why is intellectual capital so difficult to measure? 3 IC measurement 8 Generic models 3.1 Balanced scorecard 3.2 Performance prism 3.3 Knowledge assets map approach Individual company models 3.4 The Skandia navigator 3.5 Ericsson’s cockpit communicator 3.6 Celemi’s intangible assets monitor 3.7 Ramboll’s holistic company model 3.8 Bates Gruppen CompanyIQ measurement system IC valuation 14 3.9 The value-added approach 3.10 The value creation index 3.11 Market or value-based approach 3.12 Tobin’s q 3.13 Calculated intangible value 3.14 Matching assets to earnings – the Baruch Lev method 3.15 Human resource accounting 3.16 Value-added intellectual capital coefficient 4 Knowledge management 19 4.1 Knowledge process wheel 4.2 Knowledge management and the accounting profession 5 Reporting intellectual capital 23 5.1 Accounting standards 5.2 Operating and financial review 5.3 Intellectual capital reports 6 Conclusion 26 Writers: Danka Starovic, project manager, technical issues, CIMA, and Bernard Marr, research fellow in the Centre for Business Performance at Cranfield School of Management Production editor: Sarah Vaux Designer: Adrian Taylor Publisher: Chartered Institute of Management Accountants Inquiries: [email protected] (tel: 020 8849 2275) 3 Intellectual capital 1 Introduction Knowledge being the new engine of But it is not only investor pressure that necessary if the concept of intellectual corporate development has become one is forcing companies to accept that capital is to become widely accepted of the great clichés of recent years, but managing intangibles is no longer an and put into practice. there is no doubt that successful optional extra. Forthcoming legislation This is not an attempt to criticise or companies tend to be those that on issues such as the operating and devalue the traditional model of continually innovate, relying on new financial review, due to be included in financial reporting. Some intangibles technologies and the skills and the Companies Act 2003, requires large are already included on balance sheets; knowledge of their employees rather public and very large private companies others are not, for a reason. Traditional than assets such as plants or machinery. to provide a “qualitative as well as reporting has served its purpose Value can be generated by intangibles financial evaluation of performance, well, but now forms only a part of not always reflected in financial trends and intentions”. In other words, the jigsaw of how value is created statements and forward-looking companies will have to produce an and communicated. companies have realised that these are account of how their intangible assets an integral part of fully understanding contribute to overall value generation. Intellectual capital and the performance of their business. This briefing is an attempt to raise accountants in business At the height of the dotcom boom, awareness of the need for companies of In a recent KPMG survey of non- companies with almost no assets in the all sizes to manage and communicate executive directors (Neds), more than traditional sense of the word were the value of their business beyond that 60 per cent of the sample said they having their stocks more highly rated captured by numbers alone. Some didn’t consider themselves to be very than many of the stalwarts of British companies, usually large, have already knowledgeable about non-financial and global industry. Much of the implemented various intellectual capital performance indicators. In fact, it came discussion about intangibles thus grew (IC) measurement tools and techniques. last on the list of suggested topics. Not out of early attempts to account for the The rest see themselves as being too surprisingly, financial performance was sometimes staggering difference busy simply surviving to worry about at the top, with 94 per cent saying this between the so-called book and market what seems like an unnecessary luxury. was an area where they were most values of companies. Also included is a summary of some knowledgeable. As many Neds are Since then we have had the US of the current approaches and models senior managers or executives company collapses, followed by a bear used for valuation and measurement. All elsewhere, it is safe to assume this is market that continues to shrink the have limitations and many suffer from a fairly representative. value of equities around the world. lack of practical testing. But this is still a It is not simply that directors are not Intangibles still matter, but the key developing field, with contributions from up to speed on intangibles, although driver for measuring and reporting many disciplines, so the lack of some of them may well not know much them has become transparency. consensus is not surprising. More about the subject. The main reason cited Investors – understandably wary experimentation and convergence in for this worrying shortfall is that about the possibility of inflated terminology and tools will eventually be “information provided by executives is earnings after Enron or WorldCom – are mainly financial”. Comments like this putting pressure on companies to report clearly spell out the challenge ahead for all the value drivers of their accountants. As the main custodians of performance and that unavoidably performance data in companies, they includes non-financial ones. need to ensure that the right information is communicated to the 4 Intellectual capital right people. Effective strategic and individual firm, not understanding how into a perceived increased use of operational decision-making hinges on value is generated can lead to inefficient intangibles (energy-trading skills, that information being relevant, timely resource allocation. It means the provision of high-tech services). This and robust – and that means it has to company does not fully understand its sudden switch may have contributed to consist of more than just numbers. business model and may therefore be confusion among analysts and investors. This briefing is therefore primarily unable to assess the value of future Companies that measure and report aimed at finance professionals and business opportunities. On a wider scale, intangibles may experience substantial accountants in business who would like it can lead to anomalous market gains. For example, Leif Edvinsson, to implement or improve the behaviour: if the markets don’t get the former corporate director for intellectual measurement and management of information they need through “official” capital at Swedish financial services intellectual capital in their own channels they may resort to rumours company Skandia AFS, claims that a organisations. It will also be useful to and speculation, which could lead to reduction in the cost of capital of 1 per anyone looking for a general volatility. There may also be a cent was directly attributable to introduction and an overview of the key misallocation of resources on a macro the company’s ability to measure and concepts of intellectual capital and level in terms of market investments. report its intangibles. knowledge management. Some go as far as to say that the lack As long as it is relevant and timely, of understanding of intellectual capital additional information helps investors to Why should you manage by market participants contributed to assess a company’s potential for future intellectual capital? some of the spectacular market failures earnings, so helping to keep share prices Traditionally, the only intangible assets in the past few years (Holland, 2002). stable. This in turn reduces the risks recognised in financial reporting Marconi in the UK and Enron in the US associated with a company and results statements were intellectual property, are both examples of how rapid change in a lower cost of capital. such as patents and trademarks, and in the company value-creation processes There can be little doubt that looking acquired items such as goodwill. created systemic problems in the market beyond the assets reported in financial Although it is still not possible to assign for information. In both cases, the statements should be a critical exercise monetary values to most internally company value-creation processes for every organisation wholly or partly generated intangible assets, they switched out of heavy use of tangibles dependent on intangibles for its value nevertheless need to be considered if (Enron in physical energy production, creation. Finance professionals should be the process of value creation is to be Marconi in electrical goods and defence) at the forefront of this process, using properly understood. their skills and expertise in measurement Failure to do so can have damaging and control to develop systems capable consequences at all levels. For an of accommodating intellectual capital. I 5 Intellectual capital 2 Definitions of intellectual capital While there are plenty of generic capture the processes required to reach Relational capital is defined as all definitions of intellectual capital, many that stage. Intellectual capital can be resources linked to the external organisations develop their own both the end result of a knowledge relationships of the firm – with idiosyncratic definitions. For example, transformation process or the customers, suppliers or partners in Skandia