Intangible assets may not have a physical shape, but their value is as real as gold, maybe more. The value isn’t based on quantifiable units. Instead, businesses value them through different approaches.
Think of your favorite brand’s logo or catchy jingle you can’t miss. They aren’t physical items, but they have real value. They’re often the base of how we differentiate a certain brand from its competitors.
In this article, we will dive deeper into exploring intangible assets’ importance and impact on businesses.
Must Read: 10 Best Asset Management Software Systems
What are intangible assets?
Intangible assets are non-physical valuables. Businesses often rely on them as they carry a significant value. Brands, trademarks, and patents fall into this category. So does software. These assets lack a physical presence. However, they can be more valuable than tangible ones.
Consider the brand value of Apple or Nike. Their value isn’t just in their products. It’s in the brand equity and reputation on the market.
Similarly, think of a novel’s copyright. The book is physical. The copyright, though, is intangible. It ensures only the author or publisher can reproduce the book. This grants them a unique market position.
Some companies also possess trade secrets. These secrets give them a competitive edge. Like a special recipe or a unique method. Think of Coca-Cola’s formula. It’s kept in a vault in the World of Coca-Cola. Valuing intangible assets may seem abstract on a balance sheet. However, they’re crucial for assessing a company’s worth and often bring in cash flow for the organization.
Significance of intangible assets in modern businesses
Mordern businesses greatly depend on intangible assets. It gives a business moat and elevates the entry or competitive barrier for other players on the market.
Think of Google, its moat is its algorithm for better indexing and searching the internet. It has built upon the same to create a multi-billion dollar business. Is the algorithm physical? It’s intangible.
In today’s digital age, the value of a company can greatly depend on these long-term assets. Even brands without physical products, like software firms, gain value from their customer base and intellectual property.
Companies often spend huge sums on marketing to build strong brand recognition. A recognized brand can charge premium prices, even if the product’s production cost remains unchanged. Overall, intangible assets offer a competitive edge leading to higher profit percentages in sales.
When it comes to a company’s culture, it’s also intangible. However, it remains an unparalleled driver in attracting the best talent in an organization.
Importance of intangible assets
Gone are the days when factories and machinery dominated a company’s worth. Today, brands, software, patents, and intellectual property often hold more value than physical assets. It’s the age of intangible assets, and here’s why they’re so important.
1. The shift toward an intangible economy
This shift is evident everywhere. For instance, tech giants rely more on their algorithms and user data than on tangible goods. Similarly, a startup’s value might come from its unique software solution, not its physical presence.
Here’s a real example. Betterhalf.ai, an Indian matrimony matchmaking software, filed for a patent for its single-click matchmaking technology. It helps Betterhalf compete better against the big giants on the market.
2. How intangible assets create competitive advantage?
As discussed above, a patent can shield a company from competitors for years. With this protection, the firm can corner a market segment.
On the other hand, Brands, too, work as barriers. A strong brand can win the loyalty of your customer list, making it difficult for newcomers to gain a foothold. It’s not just about customer trust; it’s about market dominance.
3. Role of intangible assets in business valuation and financial reporting
The role of intangible assets doesn’t stop at creating market advantages. They’re also central to business valuation and financial reporting. When investors appraise a company, they consider its intangible assets. They know these assets can yield future profits.
In financial reporting, recognizing the value of intangibles ensures transparency. It gives shareholders a clearer picture of where the company stands.
Types of intangible assets
Intangible assets lack physical substance, but they’re incredibly valuable to businesses.
Here are some common types:
- Trademarks protect brands and logos. A recognized logo, like Apple’s apple or Nike’s swoosh, holds immense value.
- Patents guard inventions. If a company invents a groundbreaking technology, a patent ensures they’re the only ones profiting from it for a set period.
- Copyrights shield original works. Authors, musicians, and filmmakers rely on copyrights to safeguard their creations.
- Goodwill arises when one company buys another for a price higher than its book value. It represents the extra value, often tied to reputation or customer loyalty.
- Franchises grant legal rights to sell products or services under specific conditions. Think of McDonald’s or Subway outlets owned by independent entrepreneurs.
- Licenses give permission to use, produce, or sell something. A software company, for instance, may license its program to users.
- Trade secrets encompass confidential information. Coca-Cola’s recipe remains a classic example of a guarded trade secret.
Although intangible, these assets have their own value and offer a competitive edge to businesses. Simply put, managing and valuing these assets can make or break a business.
What to consider in an intangible asset?
Assets that give businesses a unique edge in the market hold greater value. Regularly monitor and review its relevance. Markets change, and what’s valuable today might not be in the future. Always consider these things while dealing with an intangible asset.
- Determine its lifespan. Some intangible assets, like patents, have a limited life, while others, such as trademarks, might last indefinitely. You should also assess its economic value. This means figuring out how much income the asset is expected to generate for the company.
- Think about protection and security. Ensure you have the right legal safeguards in place, like patents for inventions or copyrights for written content.
- Consider the impact of technology. Technological advances can either enhance or diminish an intangible asset’s actual worth.
How to value intangible assets?
Valuing intangible assets can sometimes feel like navigating uncharted waters, but with the right approach, it becomes more manageable.
1. Income approach
The income approach primarily hinges on future benefits. You start with estimating the future net income that the asset will produce. Once you have these projections, you’ll need to discount them to their present value using an appropriate discount rate.
Although it can be tricky to predict future income with the changing market, this method evaluates how much money can an asset bring into a business over its life.
2. Market approach
Just as the name suggests, the market approach draws comparisons. Look for sales of similar intangible assets in the open market. Analyze these sales to get a ballpark figure of what your asset might be worth.
This approach makes sense when there are enough comparable assets, and recent sales to examine. Otherwise, reliability decreases in the absence of relevant comparables.
3. Cost approach
Think of the cost approach as a look into the past with a twist. Instead of examining what an asset might earn in the future or what similar assets have sold for, this method calculates how much it would cost to replace or reproduce the intangible asset today.
Consider the expenses and resources that went into creating the asset in the first place. Then, factor in any obsolescence, physical deterioration, or economic factors that might reduce its value. While straightforward, this method can be tricky for assets with unique qualities or those that can’t be easily reproduced.
To summarize, an asset’s value is a function of many variables such as economic conditions, industry trends, and even global events. Consider them while valuing intangible assets.
Learn About: Cash Flow Statements: A Comprehensive Guide
Examples of intangible asset
Let these examples showcase intangible assets with a clear and real-life distribution. Dive in.
1. Brand recognition
Brands like Coca-Cola, Apple, or Nike hold immense value, not because of their physical products, but due to the recognition and trust they command on the market. A powerful brand can drive customer loyalty.
It benefits a company to charge premium prices or capture a more significant market share. It’s more than just a logo or a slogan; it’s the emotional and psychological relationship customers have with your brand.
Often, your brand becomes synonymous with the product. For example, you go out and ask, “Do you have a Coke?” What you’re really asking for is a cola drink. But Coke has become a synonym for Cola drink. This is the intangible value that popular brands drive.
When a company invents a new product or process, it often seeks a patent. The legal protection prevents other entities from producing, selling, or using the invention for a set period, typically 20 years. The value of a patent depends on its potential to drive profits, block competitors, or even license others.
Pharmaceuticals, for instance, can be worth billions if they have patent protection, allowing exclusive market access. For example, Roche’s Rituxan was first approved in 1997 in the U.S. It leveraged a patent to slice competition for almost 20 years. It’s used in the treatment of blood cancer and Rheumatoid Arthritis.
Authors, musicians, filmmakers, and other creators use copyrights to protect their original works. These legal rights prevent unauthorized replication, distribution, or adaptation of the work.
For example, the Harry Potter book series’ copyright not only guarantees J.K. Rowling and her publishers’ exclusive rights to publish the novels but also extends to movie adaptations, merchandise, and theme park attractions.
Identifying and measuring intangible assets
A well-known brand can be a treasure trove for a company. You must identify such recognition as an asset to leverage while increasing market share. Such an asset builds trust, attracts customers, and often commands premium pricing.
Similarly, a software algorithm, like that of Betterhalf.ai, should be kept confidential as a trade secret. You should identify such intangibles as assets for your organization.
Ministry of Corporate Affairs’ (MCA) criteria for identifying intangible assets.
According to the Ministry of Corporate Affairs, an enterprise can recognize an asset to be intangible if and only if:
- It’s probable that future economic benefits attributable to the asset will flow to the enterprise.
- The cost of the asset can be reliably measured.
MCA advises enterprises to assess the future economic benefits’ probability using reasonable and supportable assumptions representing the best estimate of economic conditions existing over the useful life of the asset.
Once you’ve identified these assets, it’s time to measure them. This step is where many businesses face challenges. Tangible assets have clear cost values, but intangible assets require more nuanced approaches.
When it comes to measuring them, you can use either income, market, or cost approach as discussed in the section before. In essence, intangible assets are silent game-changers. They can be powerful drivers of profit and market dominance. These financial assets help organizations make well-informed strategic decisions, driving growth and sustainability.
How to disclose intangible assets on a company’s balance sheet?
Follow the steps below to disclose intangible assets on your organization’s balance sheet.
- Identify assets. Look for trademarks, copyrights, patents, or goodwill arising from acquisitions. Differentiate between identifiable intangibles, which can be sold separately, and unidentifiable ones, like goodwill.
- Assign monetary value. Use appropriate valuation methods. For example, if you’ve acquired a patent, its fair value might be the purchase price. However, if it’s developed internally, consider the cost approach. This evaluates how much it would cost to recreate the asset.
- Present on the balance sheet. They typically appear under the “non-current assets” section. List each intangible asset separately with its respective lifespan if determinable. For instance, patents have a legal life, usually up to 20 years.
- Add notes to financial statements. Offer insights into the nature of the intangible assets, their estimated useful lives, and any significant impairment charges. It helps stakeholders understand the company’s position better.
Make sure your balance sheet accounts for any accumulated amortisation. Some intangible assets may lose value over time. Many businesses measure it through the straight-line method. Show their amortized value. It’s similar to depreciation but for intangible assets.
Challenges and Risks with Intangible Assets
Intangible assets, while valuable, present unique challenges and risks for businesses. Dive deeper to understand associated risks.
- Valuation complexity. It isn’t straightforward to value intangible assets. The method is more subjective and errors often mislead stakeholders about a business’ financial health.
- Limited lifespan. Some intangible assets, like patents, have a defined lifespan. Others, such as goodwill, don’t amortize but can become impaired. If not reviewed regularly for impairment, companies may overstate their assets’ value, leading to potential financial discrepancies.
- Protection challenges. You need legal measures and constant vigilance to safeguard intangibles like intellectual property (IP) or trade secrets. If not protected, competitors might copy or infringe on these assets.
- Rapid technological changes. Computer software or digital assets can quickly become obsolete when a new technology comes up. With their value diminishing, such intangibles can add up to financial losses.
- Regulatory changes. Regulations vary for different regions. Such changes affect the protection and values of intangibles. It might expose enterprises to financial or legal pitfalls.
- Market and economic volatility. Intangible assets are susceptible to market dynamics and consumer perceptions. Situations like economic downturns, or PR crises can erode these asset’s value in a blink of an eye.
Intangible vs. tangible asset: key differences
Physical and material possessions
Non-physical and intellectual possessions
Real estate, machinery, inventory
Patents, copyrights, trademarks, goodwill
Easily quantifiable and measured
Often difficult to quantify precisely
Can be touched, seen, and felt
No physical presence
Subject to wear and tear
May have amortization or impairment
Usually transferred through sale
Transferred through licensing or sale
Generally have a limited lifespan
Can endure for a longer period
Book value or market value
Valuation might be more subjective
Require regular maintenance
No physical maintenance needed
Technology, entertainment, pharmaceuticals
Risk of obsolescence
Higher risk due to changing technology
Can also face obsolescence (e.g., software or apps)
Often seen as more stable investments
Can be riskier due to changing trends
Remeber, the distinction between tangible and intangible isn’t always back and while. Some assets might have aspects from both.
Suggested Read: What are Assets and Liabilities? Understand the Difference
The future of intangible assets
Value of these assets will grow as we pace through the digital age, where the knowledge economy reflects an upward trend. In the software industry, SaaS companies are addressing the precise pains of their audience through niche products. The intangible is getting amplified by new algorithms coming up and companies becoming a unicorn, making space for their brand and its value in the economy.
As we advance further, patents, copyrights, and trademarks will be more valuable. And, the competition to secure this would become fierce. Present market dynamics point toward a knowledge-based economy, where the intangibles shape business operations to compete in the global market.
The bottom line
Intangible assets hold significant value in today’s knowledge-driven economy despite having no physical presence. They can influence a company’s competitive advantage and market value.
Although they pose unique challenges for valuation and accounting, you can’t understate their strategic importance in driving innovation, brand value, and customer loyalty.
Recognize and value them for sustainable business growth!
Challenges include subjective valuation, rapid technological obsolescence, lack of a clear market price, and variations in the economic lifespan, making their accurate representation in financial statements complex.
Intangible assets are accounted for at their acquisition cost and are usually amortized over their useful lives. If they have an indefinite life, they’re tested for impairment annually.
Businesses can protect their intangible assets through legal means like patents, copyrights, trademarks, and confidentiality agreements.
Yes, intangible assets can be monetized or sold, like selling a brand name, patent rights, or licensing software.
Risks associated with intangible assets include obsolescence, infringement, changing consumer preferences, and regulatory changes.
Intangible assets can offer unique value, like brand recognition or patented technology, giving companies a competitive edge.
Intangible assets play a pivotal role in business valuation, often driving a significant part of a company’s market value beyond tangible assets.
With technological advancements, new types of intangible and fixed assets emerge, like digital assets and intellectual properties related to AI. It makes their recognition and valuation even more complex.
The Ministry of Corporate Affairs (MCA) in India, and IFRS 3 and IAS 38 provide guidance on intangible assets. There are also local regulations depending on the jurisdiction.
Companies can leverage intangible assets by monetizing them, enhancing brand value, driving innovation, and improving customer loyalty and satisfaction.
Future trends can include the rise of digital and crypto assets, and increasing emphasis on intellectual properties in emerging tech sectors.