Tuesday, November 24, 2015

Recognizing Intellectual Capital

The traditional accounting model with its financial statements is increasingly inadequate in helping us understand what drives value in our business. These value drivers are highly intangible and the accounting model is not setup to measure and report these critical assets. Part of the problem is simple – it’s hard to measure intangible drivers of value. They can include things like:

  • Your ability to retain and have loyal customers
  • The fact that your workforce is highly motivated and requires minimal supervision
  • Having strong leadership that creates the right culture for performance
  • Obtaining brand recognition that makes it harder for others to compete against your company
  • Turning ideas into real product improvements for continued market leadership
  • Leveraging your know-how against the assets of others in a shared economy

In order to counter the Accounting Model, businesses will need to consider establishing a system that measures and reports Intellectual Capital; i.e. those intangible drivers of value unique to your business. Unlike financial accounts, intellectual capital accounts have a long-term perspective. They stress the importance of spending time and resources on the intangibles within the business. Therefore, intellectual capital accounts support growth, development, and innovation. It has been said that the goal is 3M: Measure to Manage to Maximize the value of these assets.

In a world where knowledge is critical, intellectual capital accounts will capture and report knowledge as one of the principal assets within the business. We no longer look at our business within the confines of the Balance Sheet, focusing only on fixed tangible assets. The intangible assets (such as knowledge, people, customers, systems, etc.) represent the stimulus for growth and value creation. The use of intellectual capital accounts can provide several benefits, including:

- Stresses the importance of developing knowledge, people, technology, and other components of intellectual capital.
- Supports organizational development in those areas that have the biggest impact.
- Provides a better indication of long-term growth.
- Assists in strategic decision making since we now have a better understanding of where our growth comes from.
- Supports how financial capital is deployed and managed, improving returns and financial performance.

Setting up a set of intellectual capital accounts can be somewhat creative. Most organizations seem to focus on at least four resource categories:

1. Human Resources - Knowledge, education, qualifications, abilities, strategic thinkers, etc.
2. Customers - Loyalty, retention, brands, agreements, etc.
3. Technology - Networks, data warehousing, executive information systems, etc.
4. Processes - Value added activities, efficiencies, cost, etc.

You need to find the right mix of intellectual assets that fits your company and define each in terms of three attributes:

1. Define what needs to be measured, such as level of professional development of personnel.
2. Define the metric to be used, such as number of continuing professional development hours completed.
3. Define the desired outcome, such as 80 hours average within the organization.

The following chart summarizes the three most common categories of Intellectual Capital and some examples of what you might measure:

If you are trying to address major Intellectual Capital components such as Culture or Leadership, you can use models such as the Denison Model for Culture or the Leadership Practices Inventory model to develop your leadership capabilities. The hard part is coming up with the right list of Intellectual Capital assets. The second major watershed event is knowing how to measure and report your growth of these assets. Granted no-one likes having to measure more stuff outside the accounting process, but because Intellectual Capital is so important to your growth, you should at least recognize your intellectual capital and realize that it is much more important than the assets showing up on your Balance Sheet.

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