Mental Arithmetic: Most Elements of a Business's Intellectual Capital Don't Find Their Way on to Its Balance Sheet, but the Lack of a Standard Evaluation Method Shouldn't Prevent Companies from Trying to Gauge Their Worth. Tony Wall Reports on Research into How Firms in Ireland Are Measuring Their Intangibles. (Finance Intellectual Capital)
Wall, Tony, Financial Management (UK)
Financial accounting professionals have spent the past decade debating how companies should report their intellectual capital (IC). Some people argue that many more of these intangible assets--beyond those associated with intellectual property such as patents--should appear on the balance sheet, because without them shareholders aren't aware of all the elements that contribute to the overall market value of their company.
The main argument against their inclusion is that no universally acceptable method of measuring them has yet been determined. Until such an agreement is reached, these assets--generally categorised as human capital, customer capital or organisational capital (see panel 1, below)--could appear at randomly selected valuations, thereby distorting the picture for investors.
Other people see the debate as far too narrow and feel that a lot of work can be done on the strategic management of IC to increase the value of any company.
IC therefore cannot be ignored and, while financial accountants may have to wait for regulatory guidance before these assets can appear on the balance sheet, it doesn't mean that the annual report can't be used as a medium for communicating how an organisation's IC is adding value. In Scandinavia--particularly Sweden--shareholders already receive a great deal of information about IC, although the reporting of such assets is more piecemeal in the rest of the developed world.
In order to gather the relevant information, financial accountants will have to rely on management accountants to capture, measure and value these assets, and to monitor any changes on a yearly basis. This, of course, will require a robust accounting system. Although several generic frameworks for this exist, the suggested measurements will have to be adjusted to fit an organisation's particular circumstances. Proxy measurements are seen as better than no measurements at all, and there are many that can be made--for example, tracking your company's investment in training and seeing whether employee turnover decreases or productivity increases as a result of that training.
In order to see how companies in Ireland (both Northern Ireland and the Republic) have been dealing with IC, the University of Ulster conducted a survey last year. Its main aim was to see what stage they had reached when it came to measuring IC. A mixture of traditional manufacturing firms and new-economy companies--ie, those in telecoms, software ere--were used for the survey.
Part of the questionnaire asked the companies to rank certain elements of IC in order of importance (see panel 2, opposite page). It's notable that the three most highly ranked elements represented each of the three categories of IC. These were software (organisational capital), customer satisfaction (customer capital) and workforce expertise (human capital).
The questionnaire also attempted to determine which elements of the three categories of IC were already being measured. The most measured elements of human capital were concerned with employee loyalty--ie, length of service and staff turnover, which were both measured by more than two-thirds of the respondents. Perhaps surprisingly, the next most popular measure concerned the number of employees with professional qualifications. Although this might seem less crucial than other elements, the large proportion of respondents measuring it is probably explained by the simple fact that the information is easy to find.
Two elements that were measured by a surprisingly small number of companies were value added per employee and new ideas generated. The first finding can possibly be explained by the problems of developing an accurate method beyond simple ratio measurements such as turnover divided by the number of employees. On the other hand, there is nothing new about staff suggestion schemes. You would assume that, if a company were to have such a scheme, it would assess how well it was working.
As with some of the human capital measures, companies were not examining certain important aspects of customer capital. For example, it's hard to believe that some businesses still aren't taking note of the number of customers they have. It is also surprising that, although many respondents said customer satisfaction was important, not all of them were actually measuring it. At the same time, almost 90 per cent of the respondents were keeping track of the number of customer complaints they were receiving.
Relatively few were measuring the effectiveness of advertising campaigns, which is precisely the sort of thing that should be measured, or there is a danger that crucial marketing initiatives will be dropped during times of financial hardship.
Out of the three IC categories, organisational capital was the one that companies measured the least. Only two elements were measured by more than half of the respondents and these were both expense items: expenditure on research and development and IT spending as a percentage of administrative costs. It could be argued that these are the simplest elements to measure, because both figures would be gathered as part of the process of drafting the financial statement.
Although some companies measured the value of new ideas generated by members of staff, not all of them kept track of how many of these were actually implemented. You would expect this to be done--if for no other reason than to provide feedback to employees.
Another point of interest was the number of companies that were failing to follow up on their employee and customer satisfaction surveys. Two-thirds of the respondents were measuring employee and customer satisfaction, but fewer than a third were monitoring any changes resulting from the feedback.
One of the most important aims of the research was to ascertain which formal systems the companies were using to evaluate their IC, having measured the various elements. Just over a third of the respondents were using no system at all. The most popular method was the balanced scorecard, which was being used by 28 per cent of our sample.
Although the remaining companies listed a variety of methods by which they measured their IC--for example, key performance indicator systems, employee opinion surveys and value-chain analysis--follow-up interviews revealed that these were generally measurement systems that focused on one particular matter, such as recruitment or procurement, and were not covering all aspects of IC. Apart from those using the balanced scorecard, only one organisation seemed to be using a comprehensive measurement system, which it called a business benefit scorecard.
There is no doubt that Irish companies are highly aware of IC--most of them are already measuring certain elements of human, customer and organisational capital. But it appears that this may be occurring as part of their normal working practices and not co-ordinated within a single IC programme. The main problem seems to be that much of the work on IC is being done in isolation and is not part of on overall strategy.
Our analysis of the companies' responses indicates that there is a lack of a defined link between a working practice, the capture of information on this practice and any evaluation of it alongside data gathered from other parts of the organisation. Furthermore, although nearly all of the companies we surveyed were familiar with the term IC, only a tiny proportion of them had people dedicated to working with it. Ireland is therefore typical of most developed nations when it comes to IC. Apart from in Scandinavia and North America, little pioneering work is being done in this area and a "wait and see" strategy seems to be in place.
1 THE KEY COMPONENTS OF INTELLECTUAL CAPITAL Human capital Knowledge Skills Expertise Motivation Innovation Entrepreneurial spirit Leadership qualities Employee satisfaction Employee turnover Vocational qualifications Education Training Customer capital Customer relationships Customer retention Customer satisfaction Favourable contracts Reputation Brand image Sales channels Distribution channels Supplier relationships Business collaborations Franchising agreements Market intelligence Organisational capital Patents Research and development Copyrights Trademarks Licences Processes Best practices Databases IT systems Networking systems Management philosophy Corporate culture 2 THE HIGHEST-RANKED ELEMENTS 1 Software 2 Customer satisfaction 3 Workforce expertise 4 Brands 5 Market intelligence 6 R&D know-how 7 Mailing/phone lists 8 Distribution networks 9 Design rights 10 Licences 11 The internet 12 Consultancy/advice 13 Manufacturing processes 14 Patents 15 Royalties
Tony Wall (firstname.lastname@example.org) is a lecturer in accounting at the University of Ulster…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Mental Arithmetic: Most Elements of a Business's Intellectual Capital Don't Find Their Way on to Its Balance Sheet, but the Lack of a Standard Evaluation Method Shouldn't Prevent Companies from Trying to Gauge Their Worth. Tony Wall Reports on Research into How Firms in Ireland Are Measuring Their Intangibles. (Finance Intellectual Capital). Contributors: Wall, Tony - Author. Magazine title: Financial Management (UK). Publication date: December 2002. Page number: 28+. © 2009 Chartered Institute of Management Accountants (CIMA). COPYRIGHT 2002 Gale Group.
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