What is intellectual capital?
Intellectual capital represents the aggregate intangible capability at the disposal of an organisation and includes legally protectable and exploitable intangible assets such as brands, distribution channel relations, product pipeline, copyrights, licenses and customer base. The term is used in a narrow sense. It connotes primarily knowledge embodied in an organisation’s databases (structural capital) and in its human resources (human capital).

How does one value a company based on its intellectual assets?
Valuation based on intellectual capital is done usually through the discounted cash flow (DCF) method. This method involves intelligent forecasts of future cash flows after considering various factors including the company’s intellectual capital. The cash flows are then discounted to find out the value of companies such as software companies.

Intangible assets, as distinct from the company as a whole, could be valued using methods like premium profits. Essentially, these methods attempt to capture the value of the intangible assets by capitalising the future stream of expected cash flows attributable to those intangible assets.

How do you divide ROCE into soft ROCE and hard ROCE?
ROCE can be divided this way. For this purpose, return as well as capital employed would have to be separated as tangible and intangible. Typically, hard ROCE would be similar for various companies in an industry except if their (tangible) capital costs are different. However, on the other hand, soft capital employed and thus the returns thereon could be and mostly are different across companies even within the same industry. However, in view of the difficulties in segregating soft and hard returns on capital employed, corporates usually use EVA as a proxy for soft ROCE.

How do you value intangible assets and disclose their values in the balance sheet of a company?
It is possible to value intangible assets and show them in the balance sheet. However, the accounting profession at present does not view this favourably and therefore most companies refrain from doing so in their balance sheets. But, many investor-friendly companies are disclosing the value of their intangible assets separately in their annual reports for the benefit of the investors.

Can the difference between market price and book value of a company’s scrip be taken as an indicator of intellectual capital?
The difference between the market price and the book value may be used as an indicator of intellectual capital if the shares are widely held and traded, and the company does not belong to cyclical sectors. In the case of closely-held or narrowly traded companies, market price may not be the true indicator of a company’s value and so the difference between the market price and the book value in such a case may not be a good indicator of its intellectual capital.

Can knowledge-based assets be valued in a bid to arrive at a fair book value of a firm?
It is likely that companies will value their intellectual capital in future in order to enable the investor community to come to a better estimate of their fair book values. As the market cap-book value gap widens, book value measurements would come under increasing scrutiny of investors and analysts who would like companies to include an estimate of their intellectual capital in their book values. This would be supported as methods to value intellectual capital become refined and standardised and accepted among the business community, and transactions of intellectual capital become more commonplace. Even emerging trends like lenders’ willingness to extend loans against intellectual capital assets would increasingly encourage firms to value their intellectual capital. However, the accounting profession, which has been traditionally unfriendly in this regard due to emphasis on conservatism, has to evolve to accept valuation based on sound norms and methods, and recording of intellectual capital in books ofaccount.

What are the difficulties in valuing knowledge in balance sheets?
As intangible asset valuation methods get standardised and accepted, people will begin to live with revalution reserves that would appear to be a lesser evil than not valuing intangible assets at all.