Money from nothing
It is ridiculous to say that humans have no value, that in the current period they're expenses and that's all they're worth.
Barry Libert is pacing around the hotel conference hall like a college basketball coach, telling his audience of local business managers that they're worth nothing. And this is what they came to hear. "Those chairs you're sitting on, they're worth more than you are," the principal from Arthur Andersen, the world's largest accounting firm, tells the crowd. "They're assets. You're expenses."
Libert has been on a vision quest that has taken him to 80 cities around the world in the last six months, lecturing businesspeople on the inability of normal accounting methods to assess the real value that most companies contain. Forget fixed assets such as furniture, equipment, and buildings. We're talking about the worth of intellectual capitalâ€"intangibles like people, ideas, reputations, relationships, and legally protected intellectual property such as patents, trademarks, and copyrights. Intellectual capital usually goes unaccounted for on financial statements. By some calculations, as much as three quarters of the value in today's companies doesn't show up on their balance sheets.
"I asked [one organisation], How much are your people worth? All the relationships, all the knowledge, all the insight, all the intellect, all the patents, all the processes, all the information about every single person and relationship inside and outside the organisation. Got any idea what their answer was? Nothing was the answer," he scoffs. "It is ridiculous to say that humans have no value, that in the current period they're expenses and that's all they're worth."
Of course, the notion that people and ideas are worth something beyond the revenue (and expense) they produced last quarter is neither radical nor new. Early American business advisor Benjamin Franklin said, "An investment in knowledge always pays the best interest," and it wasn't his idea either. What's growing is the belief that an accounting system invented in the 15th centuryâ€"one in which only brick-and-mortar investments count as assets while investments in software, training, or new business methods constitute profit-sapping expensesâ€"doesn't really indicate how companies are doing in today's service economy. It doesn't express how prepared they are for the future. It's hard to appraise what companies have underneath the balance sheets, and Libert claims this contributes to stock market volatility: Investors implicitly understand that intangibles like great technology or happy customers are the cornerstone of many tech companies, yet they have no hard numbers to refer to when nasty-sounding company news rears its head.
Libert says this information vacuum is also why managers everywhere often misapply resources. "Managers, like investors, need to know what assets their companies own and why they own them," he says. As company managers, "we measure it, and therefore we invest in it. If we don't measure it, then we don't manage it." His point is this: Let's think more specifically about which intangibles create value (that is, future revenues) in our companies, and how. Then we can get on with the business that really matters: making them worth even more.
Libert isn't alone in preaching this gospel. Baruch Lev, a business professor at New York University who has become known as the father of intangible valuation, has developed a method of appraising intellectual capital called the Knowledge Capital Scoreboard. This metric isolates "knowledge capital" as a company's earnings that are not directly attributable to its conventional hard assets, then puts a dollar value on that capital (in Lev's latest scoring of hundreds of companies, Microsoft had the most intellectual capitalâ€"US$211 billion worth). In companies across all industries, the value of knowledge capital blew away brick-and-mortar assets: The average ratio was three to one.
A new study from think-tank the Brookings Institution, "Unseen Wealth," concludes that failure to account for intangibles is responsible for stock volatility, bad public policy, uninformed business decisions, and an inadequate tax system.
Last year Securities and Exchange Commission chairman Arthur Levitt created a committee to explore financial reporting alternatives, saying, "We have long had a good idea of how to value manufacturing inventory or assess what a factory is worth. But today the value of R&D investment in a software program, or the value of the user base of an Internet shopping site, is a lot harder to quantify."
The big accounting firms are evangelists too. "We've got this ossified accounting system that got us fine through the industrial age but which isn't really adequate for a service economy," says Jonathan Low, a senior researcher at Cap Gemini Ernst & Young's Centre for Business Innovation.
FRIENDS - Regarding Corporate America, think you will enjoy the first 3 chapters of my upcoming book, I LEAP OVER THEIR HEADS!, regarding General Electric (GE) and their reprehensible behavior. You can read them by going to www.edwardbaskett.com.