What are intangible assets and why are they important?
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All companies hold various assets and these assets can be useful for calculating the company's value. While it's often straightforward to understand the value of a physical or tangible asset, there are also intangible assets that can be more challenging to value. Intangible assets often have long-term value and it's necessary to understand them if you want to understand the real value of a company. In this article, we examine intangible assets in greater detail, why they're important and the different types.
What are intangible assets?
Intangible assets are the assets a company has that have long-term financial value but are something other than physical objects. Intangible asset examples are things like intellectual property and brand recognition. These things help to generate value over time. You can consider an intangible asset to have long-term financial value if you expect the asset to last for at least one year.
These assets can have a substantial impact on the value of a company. For example, a well-established and recognisable brand can help to reach a wider customer base and generate more sales. Unlike intangible assets, tangible assets are physical items. This includes things like inventory, equipment, office supplies and IT hardware. Intangible assets can sometimes include a physical element. For example, copyright and patent documents get printed onto paper. The piece of paper is a tangible item but the asset's value lies in the copyright or patent rather than the piece of paper it's printed onto.
Why are intangible assets important?
Intangible assets are important because they give companies a competitive advantage. Brand recognition can sometimes give a company the authority to charge higher prices. It can also indicate quality and reliability. In the case of luxury brands, brand recognition and value can even indicate a high social status for the customer. Intellectual property like patents and copyrights also give a company an advantage because it means they can offer unique products that are only available from them. This can fill gaps in the market and bring them new customers.
Types of intangible assets
There are various types of intangible assets. You can usually categorise intangible assets into one of these types. Understanding what type of intangible asset you have can be useful for working out its value:
Intellectual property refers to things that someone has created using their mind and creative abilities. This includes literary works, new inventions, images and designs. You can use patents, trademarks and copyrights to protect intellectual property and prevent others from using or copying your intellectual property. These protections then also become intangible assets.
Goodwill is an intangible asset that is an intrinsic part of the company's ability to connect with consumers. Separating these assets from the company itself is impossible. Goodwill includes assets like customer loyalty, brand recognition and business strategies. These things provide value but remain part of the company, even if the business owners sell the business to someone else.
Definite intangible assets
Definite intangible assets are intangible assets that have a fixed lifespan. An example of this is a contract to use another company's patent for a certain period of time. The company loses the value of this asset at the end of the contractual period.
Indefinite intangible assets
Indefinite intangible assets are assets that remain valuable for the entire lifespan of the company. One indefinite intangible assets example is customer loyalty. Customer loyalty is valuable for the company for the entire time that it's operating and doesn't expire over time.
Related: What is customer satisfaction?
How to calculate the value of intangible assets
Calculating the value of intangible assets can be a challenge. It's important to be able to do this if you want to understand the real market value of an organisation. The following steps can help you to assess intangible assets and calculate the true market value of the business:
1. Find the value of the company's tangible assets
A helpful first step is to divide the company's assets into those that are tangible and those that are intangible. Tangible assets are usually included on the company's balance sheet. Adding the value of all of these assets gives you the total value of the company's tangible assets. Whilst these are separate from intangible assets, this information allows you to calculate the company's real market value.
2. Make a list of intangible assets
Next, make a list of all of the company's intangible assets. Think carefully about what adds value to the company other than its tangible assets. This could include logos and branding, its customer list, customer loyalty and intellectual property.
3. Choose a method of calculation
There are several methods you can use to calculate the value of intangible assets. The results might vary slightly depending on which approach you choose. Each method is useful for understanding the value of intangible assets but in some cases you might decide to use more than one method and see how the results compare. This can help you to get a more accurate result. An accountant can also help you to estimate values or decide on the right method to use. The methods you can use include the following:
The cost method. This involves calculating how much it would cost for another company to recreate the asset you have. Costs include compensation for the time and labour involved in generating the asset, materials or legal fees and registration fees for copyrights and patents.
The market method. This involves finding another asset that's similar to the one you're trying to value. This is often an intangible asset that another company holds and by using the value of this asset you can estimate the value of the asset your company holds.
The income method. This involves using cash flow projections to determine the future value of the asset for a different business.
4. Calculate the company's true market value
Once you know the value of both tangible and intangible assets, you can calculate the true market value of the company. This is the highest price that someone else might pay to buy the company that the current owner may be willing to accept. You can calculate this amount by adding together the value of the tangible and intangible assets the company holds and then subtracting the value of any debts and liabilities that the company has.
Ways of managing intangible assets
To get the most value out of intangible assets it's important to manage them effectively. When you manage intangible assets appropriately, they can increase in value. Despite this, it can be challenging to estimate how the value of intangible assets is increasing or changing. Businesses often place significant focus on brand management, especially when the brand is well-established and well-recognised. Brand management involves ensuring that the brand makes a positive impression with all of its public and internal activities.
Businesses can change or adapt their branding to respond to customer trends and changing markets. Managing customer relationships is another important aspect of managing intangible assets for many companies. Gathering information about customers, such as through loyalty schemes or account profiles, can help businesses to monitor and manage their relationships with their customers. Regardless of the nature of the intangible asset, there are some steps companies can take to manage them effectively.
Related: How to brand yourself in 10 steps
Establish key performance indicators for the asset
Establishing key performance indicators (KPIs) for intangible assets helps to measure their performance and value. It's helpful to include both financial and non-financial KPIs. The KPIs that are most useful depend on what the asset is and the industry you work in. For example, KPIs for a patent could include its expiry date, the revenue that holding the patent generates and the revenue that any royalty payments generate. For customer relationships, useful KPIs could include the average revenue that each customer generates and how frequently they make purchases.
Regularly assess the value of intangible assets
Regularly assessing the total value of the company's intangible assets and tracking this over a period of time is also a useful strategy for managing intangible assets. Annual assessments are a common way of assessing their value. Monitoring incremental earnings is an important part of this assessment to understand the value the asset brings over a period of time. Seeing how the value of intangible assets changes over time can make it easier to manage the asset and set relevant KPIs.
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