Balance Sheet

Before you start reading some theory you might like to create an invisible balance sheet yourself using the interactive page.

Letīs have a look at the “full” balance sheet of the Australian management consulting and recruitment firm Morgan & Banks, listed on the Sydney stock exchange. M&Bīs balance sheet is fairly typical for knowledge organizations.

With 592 people employed and sales of 143M, M&B is one of the largest consulting firms in Australia. The market value of M&B in August 1996 was A$ 82 Mill, thereof only 10 Mill in shareholder visible equity or net book value.
The material or “visible” component is the familiar balance sheet in annual reports. It itemizes material assets, and shows how they are financed. M&B had $6M in cash, $23M in other Current Assets and $11M in property, plant and other “tangible investments. A total of $40 M.

Visible financing in a knowledge organization is usually very simple, and M&B is no exception: short-term debt ($28M), only $2M in long-term loans (hard to arrange, because the characteristic lack of tangible “collateral” makes banks uneasy), and $10M in equity (shareholdersīcapital).

But take a look “under the surface”! There you find no less than $72M in intangible assets. From where did I derive that figure? It is the difference between the market value $82M and the net book value $10M. Note that the division of the 72M into 3 parts is arbitrary. I lack data to make a more accurate estimate.

The “invisible” intangible part of the balance sheet can be classified as a family of three:

Internal structure consists of patents, concepts, models, and computer and administrative systems. These are created by the employees and are thus generally “owned” by the organization, and adhere to it. Sometimes they can be acquired from elsewhere. Decisions to develop or invest in such assets can be made with some degree of confidence, because the work is done in-house, or bought from outside. Also the “culture” or the “spirit” belongs to the internal structure. The internal structure and the people together constitute what we generally call the “organization”. (How to measure internal structure).

External structure consists of relationships with customers and suppliers, brand names, trademarks and reputation, or “image”. Some of these can be considered legal property, but the bond is not as strong as in the case of internal assets because investments in them cannot be made with the same degree of confidence. The value of such assets is primarily influenced by how well the company solves its customersīproblems, and there is always an element of uncertainty here. Reputations and relationships can be good or bad, and can change over time. (How to measure external structure).

The intangible assets are not particularly liquid, and unlike the material assets, they may or may not be owned by the company.

Because of the reluctance of banks to lend for investment in intangible assets, the development of intangible assets is mostly self-financed. In other words, the invisible assets are matched, on the financing side of the balance sheet, by equally invisible finance, most of which in the form of invisible equity.

A knowledge organization like M&B has little machinery, other than its employees and because only people can act, they are both the minders of the machines and the machines themselves. For the most part, their competence is directed outwards, to the task of generating revenue, by solving customersīproblems. It is this outward-directed energy that creates the relationships, networks, and image that comprise the organizationīs external structure.

Similarly, it is the smaller amount of human competence that is directed inwards that creates, maintains, develops or erodes the organizationīs internal structure.

Individual competence is peopleīs ability to act in various situations. It includes skill, education, experience, values and social skills. Competence cannot be owned by anyone or anything but the person who possesses them, because when all is said and done employees are voluntary members of the organization. A case can, however, be made for including competence in the balance sheet, because it is impossible to conceive of an organization without people. People tend to be loyal, if they are treated fairly and feel a sense of shared responsibility. That is why companies are generally willing to pay some kind of compensation to those who retire, or have to be laid off. (How to measure competence).

This kind of compensation varies from country to country, but often takes the form of redundancy pay, umbrella agreements (“golden parachutes”) and pensions. Although such commitments are not recorded as liabilities in the balance sheet, they can be seen as pledges or commitments, like leasing or rental contracts, and thus a form of invisible financing of employee competence.

Now that you have a grip on the theory, why don’t you try it out for yourself? Create your own firm’s Invisible Balance Sheet on the interactive page.

Then come back here and continue with The Intangible Assets Monitor below.

The Intangible Assets Monitor is a method to follow up the Intangible Assets and a presentation format.

Continue to section How to Measure Intangible Assets.

Continue straight to The Intangible Assets Monitor.

Background of Concepts

I first used this “family of three” in (Sveiby & al. 1988): “Den nya Årsredovisningen”, (The New Annual Report). Variations of he three families have since become widely used in Scandinavia and I have seen them being used since 1993 in the US and in Canada without reference to a source.

People are the only true agents in business; all assets and structures, whether tangible physical products or intangible relations, are the result of human action and depend ultimately on people for their continued existence.

People are constantly extending themselves into their world by tangible means like houses, gardens and cars and through intangible associations with corporations, ideas, and other people. Marshall “The media is the message” McLuhan (“Media” 1967), called these intangible extensions “media”. I believe it was McLuhan who made me to see that individuals in organizations create external and internal structures to express ourselves.

If the managers of a car or soap company direct the efforts of their people inwards, they may create intangible structures like better processes, or new designs for products, for instance. When they direct attention outwards, they can create, in addition to tangible things, like cars or soap, intangible structures, like customer relationships and new experiences.

The economic value of a customer relation is no more “invisible” than the market value of a house. The reasons why the value of a relation seems invisible today is because it does not have a generally accepted definition and that it is not measured according to a standard. But these drawbacks do not mean that it is impossible or unnecessary to measure it, only that comparisons between companies and over time are difficult to make.

People in an organization can use their competence in mainly two directions: outwards working with customers or inwards maintaining/building the organization. When they work with customers they create customer relations and an image in the marketplace that is partly “owned” by the corporation, let us call this an External Structure. When people work internally they create an Internal Structure, in management literature called “organization”.

The “structure” is partly independent of individuals and some remains even if a large part of the employees leave. Even if the most valuable individuals leave a company that depend heavily on individuals, like a consultancy firm, at least parts of the internal and external structures will probably remain intact, like the name, software, manuals, registers, etc., which can serve as a platform for a new start.