The Real Valuation of Intellectual Capital - Term Paper Example

The real value of intellectual capital and how it is included in a company’s financial ment Introduction The study starts with an executive summary of the research done previously followed by a brief introduction. The techniques used to collect the data as well as the methodologies that were used to draw a sound conclusion. The research questions and the respective rationale of the study are candidly stated at initial stages of the research. An analysis of the intellectual capacity follows thereafter the mental capacity (IC) is broken down into various parts and the conclusion comes at the end of the study. Executive Summary This research is conducted on the real valuation of intellectual capital (IC) and its impact on its inclusion in company’s financial statement. The study measures the value of an enterprise, various financial assets including intangible assets as well as physical assets and shall ascertain the importance of the intellectual capital performance of an organization then just considering human capital by the management (Chatzkel, 2012). One of the intangible assets is intellectual capital, which refers to as, all the resources that are used in the computation of a company’s value and competitiveness. Intellectual capital refers to the value of a corporation or a company’s employee knowledge, business trading as well as any other proprietary information that might provide the company with a competitive edge (Freedman, 2008). Intellectual capital as a portion of the intangible assets comprises of a subset of attributes that correspond to build all the financial statements and balance sheet of a company. This research has been put forward as a means of unearthing various levels of intellectual property in enterprises today. The top management level of corporations should be in a position to have comprehended how intellectual properties have developed for the survival of any organization in the field of information and knowledge, by extracting and measuring the real performance and value of intellectual capacity (Stewart, 2005). However, the categorization of intellectual property as intangible assets only means that it is not translatable in financial terms. Additionally, the findings of this research found out that IC is mainly composed of elements including employees’ quality and how reputable a brand is among its consumers (Teece, 2007). A number of these items, even though are significant to company’s cannot be expressed in terms of monetary terms. Therefore, to unearth various levels of intellectual property, the study focuses on financial and non-financial assets of the company. My choice of references for this research was informed by the paper’s central theme- intellectual capital (Stewart, 2006). Half of the references highlight the importance of intellectual capital to the reporting of financial statement in financial reports. These articles provide evidence and implications intellectual property to companies such as improvement of company profile, enhancement of the company market value and an improvement in human relations among others (Kingsbury, 2012). The articles discuss value creation through intellectual property, and how companies can gain competitive advantages by the incorporation of intellectual capital in the company’s finances. Additionally, the references provide a wide breadth of information on strategic management of intellectual capital and organizational knowledge. The remaining half of the references highlights the impact of intellectual capital on business performance, and why it is a process that should not be ignored during the reporting of company finances (Journal of Intellectual Capital, 2013). We correlate IC to the performance of the enterprise, because value formation of intellectual capital by businesses has a positive impact on the growth country’s economy at large. These references offer information on intellectual capital and their relation to the firm’s financial statement, which was used to write a literature review. Introduction From finance point of view, intellectual capital is a blend of intellectual property that is usually held by an organization and the people in that particular group who can exploit and enhance it (Christie & Gare, 2011). Intellectual capital subset includes information capital, instructional capital, and human capital and brand awareness. In economic terms, intellectual capital has ultimate business advantage; though measuring it is a bit challenging (Spence, 2007). Number companies spend multi-billion on training and development of their employees in given a business related topics ending up paying more to increase competence of the company’s staff. This capital employed consequently generates returns to the firm hence improvement in their financial performance. Intellectual Capital and Employee Capital Components of intellectual capital can be listed as structural, human and relational capital. However, in relation to our research question we are only going to relate this study to employee capital. Employee Capital: this component is much different to the more common term “human resource”, though for year’s employee money has been used interchangeably with human resource. Human resource implies that workers are not merely expenses or cost to be minimized, but rather a precious resource the company must continuously treasure (Marcus, 2005). On the other hand, employee capital implies that humans are merely not resources the company should treasure, but also are capital the company can invest in to yield an income as well as other useful outputs over an extended period of time. The research will form a hypothesis such as “how the quality of employees does affect organization performance?” One of the primary goals of an enterprise is to possess its employee capital at a rate that can be used as profitable (Hunger &Wheelem, p15, 2010). Therefore, employee money has been created and used only in cases when the employees of the company could direct their skills and time mostly to innovative activities. In this sense, it can be concluded that employee capital is the accumulation of skills, experiences, and capabilities of staff and executives. (Burgman&Roos), considers employee capital to be a source of organization innovation and culture. Development of this capital is achievable through the consideration of ideas from employees and listening to their suggestions on how to develop the business. It is possible for companies to enlist employee capital, which also is considered as corporate capability of an organization, in the sense of benefiting from an acquired knowledge of people within its body as highlighted below: • Training • Know-How • Studies focused on data production • Research focused on forming skills and capability • Professional adequacy • Accepting and rejection of skills and evolutionism and invention. • Innovation Performance and Intellectual Capital The distinguishing capability of a company can produce to a large extent enhanced managerial efficiency, modernism and operation competence than its competitors. It is clearly stated that the more intellectual capital a business has, the more the company will have its competence, and consequently better novelty performance attained. As such, distinctive competency of the company can be regarded as the result from the company’s intellectual capital. Therefore, when a corporation has more intellectual property either in the form of employee, structural or customer capital, it will be able to create more innovation performance hence competitive advantage (Hunger &Wheelem 2010). In a nutshell, if a company has more intellectual capital, then it will possess more innovative competence required to enhance its new product development performance further. Case study Analysis of the intellectual capital for the Microsoft Corporation. Before I can make an analysis of the intellectual capital for Microsoft inc., there are some crucial factors that need to be put forward. It is very imperative to point out that intellectual capital is nothing but a combination of skills, intelligence, talent, and knowledge of the company’s human force that in turn differentiates them from its competitors. The knowledge of an organization is what is at time referred to as the brain power; therefore, intelligent capital can be viewed as the intangible assets used by the company in the making of its services and products. Intellectual capital, therefore, can be assumed to be the fundamental aspects of the company’s profit and loss statements, as well as its balance sheets. As such, the value of a business is, therefore, comprised of its financial assets, intellectual assets, and physical assets (Barney, et al., 2001). Three elements of intellectual capital include: Human Capital: Human capital mainly comprises of the values provided by business employees through application of expertise and skills ‘know how’. This component of intellectual capital is not owned by a company, and therefore when an employee leaves the company, the human capital consequently decreases (Peloso, 2008). Human capital can, therefore, be used to measure how effective a company is using its people resources as a measure of innovation and creativity. Structural Capital: Structural includes the supportive infrastructures, databases and processes of an organization that enables the human capital to function. Components of structural capital include buildings, processes, software and so on. Additionally, structural capital also includes things such as information system, proprietary databases, and organization’s image. The diversity of structural capital demands that it is broken down into: process, innovation, and organization capital. Process capital includes procedures of programs and the techniques that implement and enhance the delivery of services and goods. Innovation capital includes intangible assets and intellectual properties of the corporation. Organizational capital, on the other hand incorporates the entire organizational knowledge such as intellectual property, systems and so on (Hunger &Wheelem, 2010). This entailed its goodwill produced out of its relationship with agents, governments, partners, the brand image as well as the clients. Process capital includes procedures and programs that execute and increase delivery of services and goods. Innovation capital entails intellectual intangible assets and intellectual properties of a company. Relational Capital: A company’s licenses, franchises and trademarks all belongs to this category of intellectual capital. Precisely, relational capital also includes aspects of a business that are less definable such as relationships and customer interactions. Analysis In the year 2013, the Microsoft recorded $3987on intangible assets. This figure is a bit lower as compared to the year 2012 which was $6789. This reveals that in the year 2012, Microsoft invested mainly in intangible assets as compared to 2013. Nevertheless, given that most of the intellectual capital is being found in the intangible assets, my axiom shall rely on figures recorded in the section of intangible assets. However, since intellectual capital is mainly found in the intangible assets, the assumptions made in this research are based on figures that have been recorded under the intangible assets section. Human Capital Human capital is more significant to the company, since, as a software company, the employee’s skills, and knowledge are required to be exemplary. Meaning from the 2013 results, the company invested a little on human capital, and the result were evident for these consecutive years (Baron & Armstrong, 2007). However, by looking at their development and research column of the income statement, the company recorded a greater figure in 2013 as compared to 2012 hence the research question coined “what is the cost of acquiring new employees to the organization?”. In 2013, Microsoft recorded a figure of $25678, which is higher than that of 2012 (Microsoft, 2013). The 2012 figure was at $15895, this means that in 2013, the company invested more in their development and research for the purpose of enhancing their employees’ ability and skills towards developing new products (Marr, 2005). Additionally, the company made an $8009employee severance though it did not have in the year 2012. The employee severance of the year 2013 might be due to hard work or as a result of the fact that they had to lay off some of their employees in 2013. The little investment the company made in human capital is the only reason why Microsoft’s intangible assets for the year 2012 were less compared to that of 2013, where the company invested more in human capital to steer its projects at the time. However, for both periods it is evident that the company did spend on employees. The company spent a lot of money on employees because during this period they were busy engaged in the development of its new product- Windows 8 (Microsoft, 2013). This project not only required a lot of development and research but also required employees with high software programming skills as well as studying skills. This is the era in which a number of University students possessing good programming skills are employed by the company as interns. However, since the figure for 2013 are higher as compared to those of 2012, it is right to assume that there was a lot to be done in 2013 than there were in 2012.Most probably the development of the company’s new software known as Windows 8 was still at its initial stage where Microsoft would have required the employment of extra workforce to perform other simple tasks such as data collection. Microsoft employment strategy, which includes the hiring of in turns and temporary short-term contracts, cost the company a total of $45,789 in 2012 and $54,325 for 2013. The company also paid more money for conducting research and development on their upcoming events. As such, the company’s higher expenses for the ending year 2013 can be used to explain the business human capital. Conversely, the employment factor might as well be proved wrong by the company’s revenue. Cost of income in 2013 stood at $17,456 while that for 2012 stood at $15,394 (Microsoft, p.319 2013). The company’s higher cost of income can as well be linked to the fact employees were working an extra mile to generate more revenues for the enterprise. Despite the difference in figures on the company expenses between the two years, the employee capital was a greater in terms of revenue it earned for the company during this period. Therefore, until a model which can be used in the measuring of human capital can be designed, then this analysis will still be based on assumptions which are generated by the observation of number recorded on the company’s financial statement (Microsoft, 2013). Structural Capital The analysis of structural capital for Microsoft, I am only going to focus on assets such as goodwill and long-term assets. The aim of the study is to reveal how the company did far during the year 2013 and 2012. Therefore, when focusing on the company’s financial statement, it’s evident that Microsoft had an equipment and property that amounted to a total of $9235 in 2013 and $6895 in 2012 (Microsoft, 2013). The figure evidently shows that the company experienced a decline in the value of their equipment and property assets. Their property might include things such as working computers and buildings, as well as little things such as a touchpad belonging to the organization. During the same year, it can be seen from the financial statement, that the company had difference in the amount of goodwill recorded. For the year 2013, the company recorded goodwill of $58,576 which is slightly less by hundreds to the figure it registered in 2012 (Microsoft, 2013). This does show that the goodwill contributed to the rise of the structural capital for the company. In the financial statement, there is a figure showing that the company had quite a lot of assets in their long-term assets. But when the years are compared, the long-term assets for 2013 were lower than those of 2012. 2013 long assets stood at $1837 while that of 2012 stood at $2956 (Microsoft, 2013). This proves that Microsoft invested heavily in its long-term assets which include assets such as building and the likes. It is the equipment and assets together along with other properties that have enable human capital for the company to have adequate knowledge that is required to accomplish the demanding tasks. However, just like the human capital, it would not have been simple for a company to record high revenues in the two years without the help of structural assets. This aspect is not really shown in the financial statement, but by following the logic that states, structural capital improves human capital function to their level best, it means that having a lot of structural capital means high human capital as well increase the degree of knowledge the human capital can acquire. Structural capital and human capital in this financial statement go hand in hand, because when we focus on the company’s financial income for 2012 as well as the balance sheet, the firm’s total assets stood at $78,397 while the revenue stood at $29,943 for the same period. Consequently, the data for 2013 was at $18,756 while the company’s total current assets stood at $85,687 (Microsoft, 2013). Therefore, by studying this picture, it means the more the structural capital increases, the more the human capital also becomes stronger. The operations of a company are driven by the human capital, and therefore, while the operational income for Microsoft increases, one can conclude that Microsoft invested heavily on its human capital for it to reach this state. And since this is the case, one can as well make the assumption that the availability of the structural capital or what is commonly referred to as organizational capital, is the main factor that has made the company realize an increase in its revenue. Relational Capital Relation capital is the value that is inherent in the company’s relationship with its vendors and customers. It includes franchises, licenses and trademarks among others. These things, however, are not listed in the corporation’s financial statement, though their presence can be felt (Intellectual Property, 2005). Microsoft Corporation possesses a lot of customer relationships that includes corporations using their products such as office enterprise, as well as windows server edition. Though it is not recorded in the company’s financial statements, they exist within company’s investments such as equity. Furthermore, the fact that these investments are not mentioned provides the room for assumption that these investments might include things such as franchises. The company’s investment has seen it regain its market share, and level the playing field for most technological businesses that initially were enjoying monopoly (Journal of Human Capital, 2007). Other investments just like operations and revenue are very significant since they assist by contributing money used in driving the company forward. As such, we can be sure that Microsoft has a lot of franchises the world over as well as trademarks. And as long as this franchise, trademarks and other aspects such as customer relations exist, Microsoft will continue to realize higher revenues. Therefore, as the three aspects of IC for Microsoft have been discussed, we can also assume that all the three aspects are interconnected with one another, and they all enable the creation of the income statement and the balance sheet of the company, since without IC, Microsoft may not have been enjoying its profits as windows 8 is at a halt selling in international market. Measuring Intellectual Capital Although the analysis of Microsoft’s intellectual capital uses certain aspects of the financial reports, there is no evidence that this is precisely the case with the company. In the actual sense, IC cannot be given in terms of monetary value which, therefore, means that the analysis above is based mainly on assumptions as opposed to facts (Hunger, 2007).. The financial statement also does not record any values to show either that Microsoft human capital at no particular period of time, for instance was 60% nor does the structural capital used for the measuring of this capital. Nevertheless, studying the financial statements and bearing the fact that it is within the IC ability, that a company is able to efficiently run, leads to the above assumptions made about Microsoft according to the firm’s financial statements for both 2012 and 2013. The effect of Intellectual Capital on Human Resource Management (HRM) and Society for Human Resource Management (SHRM) The concept of IC explicitly places knowledge into three main interrelated intellectual capital components and are better explained than the other interrelated concepts. The three major IC components, namely structural capital, relational capital and human capital, provides a structured framework for various HRM practices and strategies which can be applicable to companies immediately. Human capital, however, exists in cumulative tacit knowledge as well as human skills via a sequence of various HRM functions such as employee development, deployment, and selection. The standard of human capital does increase when there is new staff joining the company. More capital is usually devoted to consequent high compensation of incomes to workers hence high productivity. However, human capital that is embedded in the corporation’s new recruits is not firm specific. As pointed out by (Burgman&Roos, p 21, 2007) whenever a company acquires human resources from an external job market, it must go through a dynamic period of alteration costs, before the best uses of human resources can be tailored and discovered to the needs of their new environment. Nevertheless, new employees who gain experience from other environments before they join the industry have an effect on their new jobs as they are incapable of learning and changing their working techniques in a new working environment. This is brought by culture shock. In a nutshell, human resources and human capital might move smoothly between firms as it is perceived. Organizations should accordingly pay more attention to the deployment and development of human capital as selection and recruitment of human resources that is not adequate to guarantee a competitive advantage. According to (Gietzmann& Ireland, p615, 2005), within the framework of intellectual capital, relation capital does capture the association external to a company, though relational capital does not replicate on the total effect of the company’s external environment. The external environment is a representation of external factors such as man-made or natural disaster, economic and or political variable that have indirect and direct impact on any company’s day-to-day activities ((Wahlgren, 2006). The organization, however, likely has no power to control or prevent these external factors. Examples include earthquakes, acts of war, economic crises and technology changes. Effect of the outer environment on intellectual capital and its relationships with companies is an area that has witnessed little research. Intellectual capital, HRM, and SHRM are all connected with the external environment. The purpose of human resources is the creation of competitive advantage that highly depends on the other two components of IC: relational capital and structural capital. Employees know-how is however most inimitable when it resides in the organization, and it is firm-specific where it was initially developed. (Gietzmann& Ireland, 2005) Argued that the learning process of an organization assists in the creation of firm-specific human capital as well as making human capital less useful to their rivals. Other structural attributes such as routines and organizational culture also help in the amplification of human capital, which in turn increases firm specificity and consequently decreases immutability. HRM managers should accordingly ignore structural capital when implementing and formulating HRM practices and strategies. Most organizations do not operate in vacuums, and in that they often do interact with their external stakeholders (Ehin, 2013). Relational capital is used as the multiplying elements in the creation of value for organizations by connecting structural capital and human capital with added external agents when representing interchange of knowledge between the external stakeholders and agencies. Guidelines on reporting of Intellectual Capital Reporting of intellectual capital does not introduce any changes to the laws of accounting, and currently they are on the trail towards testing of individual methods of measurements of IC in the value creation process, as well as a tool for communication between what knowledge management of the enterprise within a given strategy (Drahos, 2012). Reporting techniques for IC are an integral part of knowledge management processes. They offer a description of the strategy of knowledge management within the enterprise; its initiatives, its objectives and the results of the application, as well as the development and creation of the knowledge resources of a given company. The major and more frequently used guidelines includes IFAC Study no 7 (1998), Nordika Guidelines (2001) – “Intellectual Capital – Managing and Reporting”, the Danish Guidelines (2000, 2003) –“A Guideline for Intellectual Capital Statements” and the Meritum Guidelines (2002) – “Guidelines for Managing and Reporting on Intangibles”. Building on different blueprints and directives for intellectual capital would encourage companies to publish and produce intellectual capital reports. These statements can be used in the communication of the importance of IC both externally to business partners, investors, suppliers and the wider public as well as internally to staff (Chase, 2007). However, these reports are only successful if only they are set within the context of an organization strategy, and also if they go beyond the mere reporting measures as well to include interpretive and narrative commentary. Good IC reports contain the following elements: A brief introduction outlining the strategic context as well as the challenges facing the organization strategies (Caenegem, 2010). This section of the report sets the scene through the description of anticipated changes in the internal and external context along with the strategic implication for the company. It is approximately a page long. Brief narratives in the description of the strategy as well as a visual representation of the company’s value creation map. It is important to point out the casual relationships and interdependencies between different elements of the strategy and in specific how IC value drivers assist to deliver the company’s strategy (Brooking, 2007). This narrative should be about two pages in length. A description of all the value drivers of intellectual capital at this section, a more detailed description should be offered for all the value drivers of IC, by outlining the strategic targets, objectives, and associated activities whereas, performance indicators and possible data should be used in the clarification of goals and objectives (Bloomfield, 2008). Brief descriptions of the key activities (projects, tasks, and programs) which are planned to help achieve objectives are supposed to be provided. For every description, the length should be one and a half page long. Value creation and success in today’s economy is all being driven by intellectual capital (Bainbridge, 2009). In order to impact the future value positively, it is, therefore, vital to managing and understand the intellectual capital which underpins value creation within the company. Reporting of intellectual capital represents a particular aspect of the intellectual capital management. Conclusion In a nutshell, beside the fact that intellectual capital cannot be determined in monetary value makes most of the financial analysts to have a hard time in ascertainment of how a company fares on as the aspect is concerned. However, the methods of measuring a corporation that exist are dependent on other factors such as relations of the company with its customers and how many employees does the company owns as well as how employees well sophisticated are they to cater for business needs? All the same, these existing difficulties do not deter a company from measuring the intellectual capital because it is until the enterprise knows how its fairing on the field that it will be able to comprehend the direction it should take. Microsoft Inc shall be required to measure the human capital to know if to add more employees and there exist a need for that then the company to know which type of workers they should employ. Conversely, the Microsoft needs to measure the structural capital to know if indeed the company requires new equipment. Most of the analysts have come to know that intellectual capital plays a vital role in the formation of financial statements of the company. This is seen in both 2013 and 2014 financial statements of Microsoft. It requires more analysis to understand it, and the fact remains constant that this form of capital is indeed hidden in the financial statement of the Company. References Amidon, S. (2010). Human Capital (2nd ed.). New York: Farrar, Strauss, and Giroux. Bainbridge, D. (2009). Intellectual Property. Harlow: Longman. Baron, A., & Armstrong, M. (2007). Human Capital Management: Achieving Added Value Through People (4th ed.). London: Kogan Page Ltd. Bloomfield, S. (2008). 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