When Balance Sheets Collide With the New Economy
TODAY’S sophisticated knowledge economy is stuck with the equivalent of an abacus for measuring the actual financial value of corporate assets and liabilities.
At issue is a growing collection of crucial resources known as intangibles: assets or liabilities that have no obvious physical presence, but that represent real value or vulnerabilities.
Patents, trademarks, copyrights and brand recognition are most commonly recognized as intangibles. But as the nature of doing business has changed, the list has grown.
For example, the most valuable assets of an innovation-based company today — its intellectual property, software investments, staff and managerial expertise, research and development, advertising and market research, and business processes — have no natural home on the balance sheet.
They can be recorded as expenses or sometimes, in the case of intellectual property, as liabilities, says Nir Kossovsky, the chief executive of Steel City Re, which assesses and insures companies’ intangible assets. But often, they do not make their way onto the accounting ledger at all.
Reputation is one such intangible asset; ask Mattel about its value, after its third recall of toys this summer. Or JetBlue Airways, which built a stellar reputation for customer service but neglected to fortify its computer network. When that network failed in the winter and stranded thousands of customers, the company’s stock price and good name both took tremendous hits.
What’s more, the market is demanding that companies prove that their business conduct is environmentally and socially conscious — not on the basis of ideology, but because to do otherwise exposes them to financial risk.
The vulnerability of a global economy to cataclysmic risk, from terrorism to pandemics and extreme weather, is also pushing companies to disclose processes and strategies they have to ensure continuity after a disaster.
But because accountants have found it impossible to determine the value or the risk of such assets with certainty or objectivity, official financial accounting rules give intangibles a wide berth.
Instead, each company makes its own valuation of intangibles, guided only by very general accounting standards. “There is not the rigor and uniformity that governs the valuation of ‘tangibles.’ In all cases, there is little relationship to market value,” said Mr. Kossovsky, who is also the executive secretary of the Intangible Assets Finance Society, an advocacy group that is working to develop new standards and practices for monetizing intangible assets.
Yet today’s markets are being transformed by intangibles, and a growing number of companies are scrambling to find the methods that will help them better use, develop and communicate about them. “In the last three years, investors have been looking at how social and environmental issues translate directly to market value,” said Jed Emerson, a senior fellow at the Generation Foundation (the philanthropic arm of Generation Investment) who is credited with developing an approach to assessing intangibles called the blended value proposition.
“Mainstream business is less and less able to function without paying attention to these things,” Mr. Emerson added. “Ten years ago, at the World Economic Forum, the talk was all about opening new markets and currency exchanges. Today, it’s about AIDS and education systems in South Africa, and things that you wouldn’t have historically heard major C.E.O.’s voicing concern about.” Stakeholders in emerging markets “want to know how investment translates to jobs, environmental concerns, etc.”
Over the past couple of decades, finance experts and strategists have developed many methods to better value various intangibles — methods that corporations and governments are widely adopting.
For example, one of the earliest approaches, the “triple bottom line” (for “people, planet and profit”), was ratified early this year as the standard for urban and community accounting by the United Nations International Council for Local Environment Initiatives. According to the consulting firm Bain & Company, a more recent approach to valuing intangibles, called the balanced scorecard, was being used in about 57 percent of international companies by 2004.
As yet, none have been adopted as a standard by the official financial accounting bodies. But it is only a matter of time until they do, according to Sara Olsen, founding partner of the Social Venture Technology Group, a San Francisco firm that specializes in developing nonfinancial valuation methods.
Ms. Olsen noted that leading business schools are already training students in these new, inclusive valuation methods, and that many companies are also busy teaching others how to credibly analyze their own intangible assets.
Leading public companies recognized the value of the process some time ago. In April, Fast Company magazine teamed up with the S.V.P. Group and the social investment strategy firm HIP Investor to rate the human and social impact of 21 companies that say they have sustainability practices in place, including Wal-Mart Stores, United Technologies and McDonald’s.
“I would put money on it, that within a generation this will be a commonly accepted management practice,” Ms. Olsen says, with its own standards body like the Financial Accounting Standards Board that maintains, updates and oversees enforcement of best practices for valuing intangibles.
Many who have been working in this area agree. Not only is the change inevitable, they say, but it is well under way.
“Some people think the logic of econometrics was handed down by God, but it’s actually the result of 40 or 50 years of economists and accountants arguing about corporate performance,” said Mr. Emerson of the Generation Foundation. “We’re now at the early stages of evolving that process. Today it’s a very different conversation, and all these efforts to capture value more wholly — at the corporate level, across companies, and at the broader level of society — are positive examples of innovation.”