Meeting the new accounting challenge

There is an increased realization that traditional accounting methods are failing to measure the real impact of people on business. We see this on the stock market each day when businesses are valued by many times their financial book value.

Twenty years ago when a private sector business valued its wealth, it essentially meant the value of the price equalled the fixed assets, such as buildings , plant and machinery, in the balance sheet. Now we are seeing a dramatic shift in how worth is being judged. Starting with the remarkable case in 1995 when IBM bought Lotus for US$3.5 billion, fourteen times their book value. Marketplaces have come to place immense value on the value of intangible assets such as intellectual property and the know-how to speculate on the future of a business. We only have to observe how IBM has benefited from their investment in Lotus to understand how wise was their initial decision.

Oracle is another example of the value of know-how. Its shareholder value has been worth up to twenty-five times its book value (96 per cent for intangible assets and 4 per cent for tangible assets). Such judgement of perceived value indicates that the business community now places a much higher weight on people s ingenuity and talent. Other point in time examples of the weight for intangible assets include Coca-Cola (95 per cent), Kelloggs (95 per cent) and IBM at 93 per cent.

Even Ford s book value, with the organization s massive balance sheet of tangible assets, only accounts for an average of around 35 per cent of its current market value. The remaining percentage balance is the perceived worth of its know-how. Then there are the many businesses and government operations which are not listed on the stock exchange; their perceived value to customers and the community is often seen to be much more than the cost of running them. People look at the perceived value they contribute to the society. For me, a classic example is the host of charities and voluntary organizations that have little or no fixed assets but provide a wonderful service to society.

The measurement of this so-called know-how factor has now become a huge preoccupation for business strategists across the world. It is worth noting upfront that currently there is no universal standard or agreement on how this measurement is to be done. The Saratoga Institute in the USA has developed over 250 metrics for what they call human capital. Karl-Erik Sveiby a pioneer in this field on his web site at www.sveiby.com.au has noted at least twenty-one different approaches to measuring intangible assets or intellectual capital. Given these conflicting opinions and debates on terminology, it will be no surprise to discover that accounting for know-how is not yet a part of normal business practice. McKinsey and Company in a study of thirty-three of Australia s top companies found that only 25 per cent of them recognized the importance of intangible-wealth performance, preferring in most cases to see people as cost rather than wealth generators. However, the Swedish company, Skandia, has been producing reports on the net worth of their people for nearly a decade , so for them this discussion is nothing new.

What makes this field difficult and somewhat controversial is the problem in directly linking knowledge and innovation with better performance as factors such as good morale , customer relationships, branding and a smart learning culture are often very hard to place a value on. We know it is important, but how important? For example, when Ford bought Jaguar it reduced the defect rate to 8 per cent of previous levels, but can Ford claim all this success or were there other factors affecting this astounding result.

Another example might be when a business decides to reduce costs by making forced redundancies. On the balance sheet such cost cutting may give a favourable result but how about the loss of talent, drop in morale and reduced customer loyalty? Will the decision have a direct or indirect impact on the long- term capability and viability of the business? Such questions are central to modern management s desire to ensure lasting success through better reporting of the value of its knowledge.