We’re looking at it all wrong: the intangible information gap

I have been really heartened to see more attention to the way that the intangible information gap skews investors’ understanding of what’s really going on in today’s knowledge-driven companies. This latest article comes on the heels of a Reuters piece last month calling for getting intangibles on the balance sheet.

Yesterday, this new examination came in Jeff Saut’s Market Call column where he quoted Steve Vannelli of the GaveKal Platform Company fund talking about technology and intangible capital (I added the bold):

To this technology point, I asked Steve to discuss his “knowledge,” or intangible capital, theme. He responded by stating that our current accounting system doesn’t value “intangible capital accumulation” appropriately. Most certainly, intangible capital accumulations are “expensed,” not capitalized. Such accumulations increase productivity, foster more efficiency, and drive better financial money flows than are currently measured. Moreover, if you are not measuring such metrics correctly, you are also not measuring our country’s “economic output” correctly. For example, “What is Amazon’s (AMZN) “search engine” worth? Read more

Imagine that. Measuring intangible investment at the company level?!

To date, economists have focused on measuring intangibles at the macroeconomic level. And they have developed compelling data showing the growing importance of intangibles to economic growth.

But accountants and business leaders have been slow to pick up on this. The only widespread application of intangibles measurement comes through the Balanced Scorecard approach and the growth of the performance management field. The problem that I have with both of these approaches is that they are ignoring the powerful starting point of intangibles value creation that the economists have laid out for us: investment. Read more

Will Intangibles Ever Go on the Balance Sheet?

This week, we’ve been talking about collecting data on intangibles investment.

This discussion seems to beg the question of how it will be used. In contemporary accounting, the investment by an organization in tangible assets is “capitalized” on the balance sheet and depreciated over time. This serves as a way of keeping non-operating expenses (that is, not related to the current year’s operations) out of the income statement. It also serves as a way to track the cumulative effect of investing in a company’s capacity over time. As we have explained in previous posts, this model is not used for intangibles.

So if we recommend tracking intangibles investment, does that mean that we think  intangibles should go on the balance sheet? Read more

Analyzing I-Capex: How to understand the return on your intangible capital expenditure

This is a follow-up to yesterday’s post about intangible capital expenditure.

When you are starting out, an i-capex report will just be a separate report in your accounting system or in a spreadsheet to be used to report to management or your board of directors. Ideally, you should go back a few years so that you start out with a data series that you can use to learn about the patterns of your spending. When you do this, you might want to also gather some demographic data that can be used in calculating ratios.  Read more

Intangible Capital Expenditures: How to track your annual i-capex

Last week, in my interview of Alan Anderson and Chuck Hulten on accounting and intangibles, Alan made a statement that has stuck with me: That in all his travels in his own business and through his activities with the AICPA, he has never heard people say that they use their GAAP statements to make business decisions.

But businesspeople use their accounting information all the time. They just use it for presentations and analyses that better suit their needs. This is often called managerial accounting as opposed to statutory reporting (which conforms with GAAP or IFRS).

This post is about just such a use. It is about tracking the amount of money that you invest in intangibles each year.
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Why are intangibles not on the balance sheet?

Up until the 1970’s, the consumers of financials—managers, analysts, investors and bankers—had a much easier job. They had three sets of information by which to measure their investments.

1. Balance sheet. In those days, balance sheets did include all the important assets of a corporation and looking at the balance sheet gave you a good idea of the corporation’s capacity to grow and thrive in the future.
2. Cash flow statement which showed you the investments (capital expenditures) the company was making in its future. This was a critical statement for us when we were bankers because it showed the split between short- and long-term spending and financing.
3. Third was the income statement, which told you how the company was putting its assets to work from year to year. The income statement also includes depreciation and amortization, which expense a share of the cost of capital investments each year over the useful life of the asset.

The rise of the knowledge economy has broken this model. The balance sheet does not include intangibles. Investments in intangibles instead are mixed in with current year operating expenses. And no one knows how much is spent on building intangibles within an organization. Read more

Measuring Intangibles: The Simple and Elegant Answer

A few years ago, a colleague from the Institute of Management Consultants, Michael Egan, approached me after I gave a keynote address on intangibles at the Institute’s annual conference. Michael’s firm built a platform a number of years ago that is used by industry association members to anonymously report benchmarking data. The postings by individual member organizations are reported back to everyone in the system with useful averages so they can see how their organization compares to industry norms. Michael was sure that there would be opportunities for reporting on intangibles.

Our first response was the standard response of everyone in the accounting and the intangible capital communities, that you cannot really measure intangibles in dollar terms. But we kept thinking about it and then one day a light bulb went on. Read more

I-Capex Is the New Capital Expenditure

Capital expenditure (capex) is an accounting concept that has ingeniously supported the tangible economy for centuries. It allows a company to apply to its balance sheet the cost of investments in its future productive capability. This is called “capitalizing” an expense. Then the cost of this investment or capital is depreciated over a period of years. This is an extremely important feature that helps companies avoid having to show decreased earnings in a period where they make large investments. It is through a corporation’s capex that the tangible production value of the company (and by extension, its balance sheet) is built and maintained.

The idea of capital expenditure is actually very relevant to intangibles. U.S. businesses are already investing as much or more on their intangibles as they are on tangible investments in property, plant, and equipment. We know this from macroeconomic data. And we can see the benefit of it in stock and valuation data. But we don’t really know on the individual company level because no one counts it. That’s right. No one really knows how much is being spent on intangible capital expenditures (i-capex) by American companies to build their knowledge infrastructure. Read more

The Hulu IPO: Wrong thinking on intangibles accounting hurting its chances

The internet television video company Hulu is reportedly considering an IPO. But, reports the NY Times, the company “evidently makes little in profit.”

I am not privy to their numbers but I can tell you from experience that their income statement is probably full of “expenses” that are actually investments in their intangible productive capacity (also called intangible capital). These include investments in some investments in processes, training, networks, and other forms of organizational knowledge. Read more

Intangibles Measurement II: Investment

Here’s the next installment in my intangibles measurement series. I always warn folks that this the most radical of the three types of intangible measurement, although it shouldn’t be.

Today, any money you spend on building intangibles gets expensed. Even if you are investing money to build something you expect your company to use for many years to come. This means that most of the money spent on developing internal knowledge systems, operational processes and even relationships with key partners is treated as a direct operating expense on the income statement in the year that you make the investment.

There are a lot of valid accounting reasons why this is the case. I’m not out to change accounting. But I  focus on helping companies make better decisions to grow and improve performance. And the secret to that, except when my clients are buying a new machine (which isn’t that common), is to invest in intangibles like process, IP, people and networks.

So here’s my radical proposal: keep track of how much you are investing in intangibles every year. Read more

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