Budget Accounting

Creating Value through Intangible Assets Management: To achieve sustained profitability, todays companies must pay greater attention to their non-material production factors and thus require new management and reporting instruments By Juergen H. Daum

In difficult economic times, hard topics like cost efficiency and profitability come to the

fore. But companies and their managers must exercise caution: too close a focus on the

bottom line can prove shortsighted, and all-too-ambitious attempts to trim the fat from

costs may cut out vital muscle as well a fact which they may not recognize immediately.

Simply studying the profit and loss statement or the balance sheet won't reveal the factors

behind sustained financial success that have become decisive in every industry in our modern

economy: intangible assets in form of human capital, business relationships, brand

recognition, ideas, expertise, corporate culture, power to innovate, and public reputation.

Growing importance of non-material production factors

Over the past decades, companies have invested increasingly in the preparation of their

operative activities and processes used to supply customers with products and services. They

have accelerated investments in research and development, brand building, establishing

customer relationships, staff training, and information technology. These expenditures were

primarily reported as costs, but their investment character helped add non-material value.

Such intangible assets do not appear on any balance sheet, yet potential investors or buyers

when evaluating a company consider them.

One clear indication of the trend is that the portion of a companys book value compared with

total market value has decreased on average from 60 percent of in the early 1980s to only 20

percent at the end of the century. That means that of the productive factors of a company that

are reflected in its market value, only one fifth is still captured and reported through its

accounting system that serves as the foundation for external corporate reporting and for

internal management control.

copyright 2002 Juergen Daum (www.juergendaum.com). All rights reserved. Use of quotes of text taken from this article

or of its graphics is permitted only with reference to the author and his website.

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Focus on intangible assets in difficult times

20 years ago, when a much smaller portion of the value creation potential of an enterprise has

been ignored by the corporate accounting and management systems, also the probability was

much smaller to cut into productive flesh through a cost cutting program. That is because a

cost focused approach recognizes only those items and activities, that are reflected in the

accounting system. Todays cost-cutting measures pose therefore a much greater risk of

inadvertently ignoring and destroying resources potentially important to the companys future

or the activities that create and maintain these resources.

In addition, empirical studies have revealed that investments in traditional industrial assets,

that is in physical assets, just return their cost of capital, but do not create value added. Our

service-oriented and knowledge-based economy of today creates added value, that is returns

beyond the costs of capital, primarily through innovative work in strategic management,

product and market development, and by creating unique relationships with customers,

business partners, and other stakeholders, such as employees. But to make this possible,

managers have to develop the capability to assess the expected return on investment in R&D,

employee training, information technology, brand enhancement, and other intangible assets

and compare these returns with those of physical investment in an effort to achieve optimal

allocation of corporate resources.

But that is exactly the problem: Today, most business enterprises do not have the information

and monitoring tools required for the effective management of intangibles. So investing in

these new type of management systems may become an important tasks especially during an

economy slowdown.

At the beginning of the 20th century, industrial mass production served as the motor to

generate value; this required more complex cost accounting, beyond the abilities of previous

accounting practices, to enable management to control and optimize the efficiency of these

new value creation processes from an economic perspective. In the same way, we must now

expand accounting and controlling systems to a new level, to enable companies to optimize,

manage and report on todays new value creating activities and processes for example in

the area of strategy management, in the product innovation and commercialization process as

well as in the creation of relationships with customers and business partners.



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Increasing demand for a holistic approach

The true value of intangible assets becomes apparent only within a specific context.

Investments in human capital such as additional training generate reduced costs or

increased revenues only when combined with such other factors as reengineered business

processes or the availability of appropriate information systems. Investments in product

development will lead only to a market share that is able to return these development costs

plus a profit if the company disposes of relationships to potential customers and marketing

partners for these new products that allow a fast commercialization before competitors are

able to catch up.

Therefore, the entire enterprise value creation model within which the intangible assets are

created and in particular utilized must be taken into account. In this process, it is

important to develop a strategy for bundling all of a companys sources of value creation

potential into a single recipe for adding value.

From financial accounting to business accounting

Only a consideration of the entire system enables you to decide if, for example, you can post

investments in product development as assets in accounting. Baruch Lev, an expert in

accounting for intangible assets and a professor at the Stern School of Business of New York

University, recommends that you capitalize such expenditures as soon as you have

information confirming that they lead to positive and secured economic results1. But you can

do so only when in the framework of the product development process information on

marketing and customer relationship processes can be accessed, analyzed, and verified with

tests as early as possible . Accordingly, accounting must become more closely geared to these

new value creation processes, just like classic industrial cost accounting and the traditional

income statement had to be closely linked to production processes in order to report product

manufacturing costs /costs of goods sold.

It follows that the traditional financial accounting process must be built up into an extended

business accounting function that reflects the companys specific business model. In addition

to manufacturing costs, financial statements should separately identify the costs of all



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1 Baruch Lev, Intangibles: Management, Measurement, and Reporting, Washington D.C. 2001, p. 122-127 see the interview between the author and Baruch Lev at http://www.juergendaum.de/news/03_06_2002_d.htm

relevant value-creation activities such as in product development, investments in human

capital and employee competencies, market partner network building etc. Expenditures,

which provide investment character, could be capitalized as assets, as recommended by

Baruch Lev, as soon as the sustainability of the created potential is secure. Depreciation can

start, when revenues are generated from these investments. This would increase the

transparency of the income statement, because expenses with investment character do not

distort it any more. In addition, companies would be able to report more precisely on their

return on investment, because the equation would include all investments no matter if they

are of tangible or intangible character.

Transforming cost accounting into an enterprise management system

In addition, traditional cost accounting must be expanded into an enterprise management

system that spans the entire spectrum of the enterprise value creation system and that focuses

not only on cost efficiency, but takes into account at the same time the companys

effectiveness in meeting market and stakeholder expectations.

This approach encompasses ongoing strategy management, a process that helps to control the

enterprises value creation recipe and, by means of strategic programs, to adapt it

continuously to new market conditions; corporate performance management, that optimizes

total enterprise performance across all economic subsystems and value creation activities;

and business controlling, which helps control and continuously optimize the individual value-

creating activities per se in such areas as product development, supply chain management or

customer relationship management, as well as resource management processes in human

capital, finance or information technology management.



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Overall View

Revenues, Profit, EVA Return on Intangible Assets

Market shares Customer satisfaction

Reliability

Supply chain efficiency Value added per person

IT efficiency

Status project 1 Status project 2

Financial Results

Market / Customers Processes / Resources

Change Management

Status of total corporate performance

and of strategy implementation

Product/Market Development View

No. of successfuldiscoveries

No. of usablesuggestions from the user groups

Effectiveness of R&DAlliances

Return on develop-ment investments

No. of registeredpatents

Success and errorquota of beta tests

Time-to-market

No. of marketingpartners

Market shares Innovation revenues(revenues of products < 2 years)

Brand value

Discovery Implementation Commercialization

Operational View

Delivery reliability Lead time Utilization / costs SCM flexibility

Average customerlifetime value

Lead conversion rate Customer satisfaction Service quality

Supply Chain Cockpit CRM Cockpit

Resource Management View

Productivity Vacancies quota Fluctuation

Cost efficiency Reliability Service quality

Working capitalemployed

Costs per transaction

Efficiency and effectiveness in product development

Efficiency and effectiveness of customer related

processes and supply chain management

FinanceHuman Resources IT/Information SystemsEfficiency and effectiveness

of resource managementprocesses

Tableau de BordSt

rate

giy

Man

agem

ent

& C

orpo

rate

Per

form

ance

M

anag

emen

tB

usin

ess

Con

trol

ling

2002, Juergen H. Daum, www.juergendaum.com Figure 1:The Tableau de Bord the management information system that helps to control and optimize total

enterprise performance

The major element in such a control system is a comprehensive yet compact set of metrics

and key indicators the so-called Tableau de Bord (see Figure 1). This scorecard, which

enables the systematic monitoring of performance and risk in the companys overall value

creation system, is a cornerstone of the new enterprise management system. In addition,

companies need management processes that permit quick and efficient exchange of

background knowledge between individual managers to ensure optimal usage of this

information. Such processes include a strategic management process that establishes

continuous, strategic dialog throughout the company and thus ensures that the company

remains a nose ahead of external developments that could harm its intangible assets based

competitive position. Companies must also have a process for performance management that

optimizes the exploitation of existing assets in order to achieve short-term profitability goals.



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Both enterprise management processes need to be linked with operational management

processes through clearly defined checkpoints (see figure 2) 2.

Management Processes

MeasurePerformance

Performance ManagementProcess

Adjustoperations

Decidehow to adapt

StrategicAnalysis

DefineObjectives

Adapt/DefineStrategy

Strategy Management Process

Forecasting

Go DecissionBusiness

Development

Market Research

Test & Release

Check Technical Feasibility

Prototyping

Implementation

Product Lifecycle Management

DemandPlanning

ProcureRaw Material

Production

SCM

ProductionPlanning

Delivery

Lead Generation

CRM

Engagement

After SalesSupport

CustomerService

Sales

Support Processes/Resource ManagementHR FinanceIT

EnterpriseManagement

OperationalManagement

ManagementSupport

Building strategic value creation potential (long term)and managing (short term) performance

Optimizing operative activities and processes (with respect to costs, periodic results, lifetime results)

Acquiring and developing resources

2002, Juergen H. Daum, www.juergendaum.com Figure 2: Management processes as an organizational framework that supports management dialogs

throughout the enterprise to optimize continuously trade-offs and increase enterprise total factor productivity

From financial statement reporting to business reporting Moreover, traditional external corporate reporting, based nearly exclusively on financial

statements, must be expanded into a more comprehensive business-reporting framework. The

objective: to provide investors and other external stakeholders with a better insight in the

enterprise and, by giving them an overview of all value-creating activities from an economic

view-point, to enable them to better assess true potential and the companys ability to achieve

sustainable results from this potential.

For example, in addition to financial statements, companies could publish supplemental

information on business strategy and business models, along with operational and intangible



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2 Juergen H. Daum, Intangible Assets and Value Creation, John Wiley & Sons Ltd, Chichester, 2002, p. 255-372

key performance indicators via so called supplemental corporate reports. Working groups of

the U.S. Securities and Exchange Commission (SEC) and Financial Accounting Standards

Board (FASB) have suggested this approach, and the intellectual capital statements

proposed by the Danish government represent a similar step. Thus, the same concept that is

used for internal enterprise management, as described above (Tableau de Bord) can be used

as well as a basis for external corporate reporting. It might be less detailed than the internal

performance reporting systems and some information will be excluded from the external

reports for competitive reasons.

In addition to the one way corporate reporting process, management needs to initiate and

maintain with important external stakeholder groups a continuous active bi-directional dialog

in order to get and keep them engaged for the enterprise: stakeholder relationship

management becomes a daily top management task and needs therefore to be integrated with

the internal management processes (see figure 3).

Corporate Reporting und Communications

Background Info

z Theory of Businessz Strategyz Business Modellz Management challenges

andopportunities & risks

z Stories / examples

Strategy Implementation/ Total Performance

Operations:CRM + Fulfillment

Ressource management (HR, IT, Finance)

Product Innovation

KPIs / Measures

Tableau de Bord

ExtendedReporting

StakeholderDialog

InternalManagement

Processes

StakeholderEngagement

Process

Communicationto the public

z Ilustrated printedannual reports

z Timely and continuous reporting on the corporate website

z Others Mise en Scne of a companys essence(e.g. through a corporateevent center ...)

InstitutionalizedStakeholder- /Public Dialog

2002, Juergen H. Daum, www.juergendaum.com Figure 3: The extended Corporate Reporting und Communications framework



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Combination of old and new success factors

The recipe for present and future success at companies in all business sectors combines

(short-term) profitability with the development of (longer-term) non-material potential in the

form of intangible assets. Thus, enterprise management becomes a sort of balancing act:

Companies must not only ensure short-term profit and cash flow to finance the future, but

also ensure that the programs for developing potential in a fundamental sense are in place and

on track.

To achieve this, management must have a broad and deep understanding of all essential value

creation activities of the company. They must learn to apply systems thinking so that they can

estimate the dynamic interactions in the system and their overall affect on long-term success

of the company.

Bad management decisions that result from an inability to recognize and properly manage

intangible assets will, at a minimum, result in lost opportunities for growth. Ultimately, they

may threaten a companys existence. A management system that enables managers to

systematically avoid making incorrect decisions can have a major effect on a companys

success and help achieve sustained profitability. Supporting management and information

systems themselves then become an important production factor.

About the author: Juergen H. Daum is a senior business consultant at SAP AG, Walldorf/Germany, and advises companies on an international level in the areas of financial and management accounting, enterprise management and control and information systems. Before that, as a program and product manager at SAP, he was responsible for the strategic repositioning of SAPs financial and accounting applications, mySAP Financials, and defined the concept for the SAP Strategic Enterprise Management (SAP SEM) solutions. Before joining SAP, he was CFO and controller of an IT company in Germany. E-Mail: [email protected]

You will find more information about this articles topic:

In this book: Intangible Assets and Value Creation By Juergen H. Daum John Wiley & Sons Ltd, Chichester, 2002 ISBN 0470845120 (see also: http://www.juergendaum.com/mybook.htm)

At the website of the author at: http://www.juergendaum.com/

copyright 2002 Juergen Daum (www.juergendaum.com). All rights reserved. Use of quotes of text taken from this article or of its graphics is permitted only with reference to the author and his website.

Seite 8

Growing importance of non-material production factorsOver the past decades, companies have invested increasingly in the preparation of their operative activities and processes used to supply customers with products and services. They have accelerated investments in research and development, brand building,Focus on intangible assets in difficult timesIncreasing demand for a holistic approachFrom financial accounting to business accountingTransforming cost accounting into an enterprise management systemFigure 1:The Tableau de Bord the management infFigure 2: Management processes as an organizational framework that supports management dialogs throughout the enterprise to optimize continuously trade-offs and increase enterprise total factor productivity

From financial statement reporting to business reportingFigure 3: The extended Corporate Reporting und Communications framework

Combination of old and new success factors

Budget Accounting

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