People pay a great deal for a particular car or a particular suit, and much of what they are paying for is not the materials or the stitching. It is the name and what it signals. A strong brand lets a company charge more for a comparable product, and that pricing power is worth money — which raises an awkward question for accounting, because a brand cannot be counted in a warehouse.
What Counts as an Intangible Asset
- Brands and trademarks — the pricing power a name carries.
- Patents and intellectual property, which are time-limited monopolies on an idea.
- Copyrights, software, and content libraries.
- Customer relationships and contracts, including the value of a subscriber base.
- Licenses, permits, and regulatory approvals that are hard for a competitor to obtain.
- Know-how, processes, and trade secrets.
- Goodwill, which is a particular case discussed below.
In many modern companies these are worth more than everything physical the business owns, which is why a purely asset-based valuation can be badly wrong.
How They Are Valued
- Income approach — estimate the future cash the asset generates and discount it to today. For a brand, this often means estimating the premium it commands over an unbranded equivalent. The most common approach and the most assumption-dependent.
- Market approach — look at what comparable assets have sold for. Reliable when comparables exist, which for genuinely distinctive assets they frequently do not.
- Cost approach — what it would cost to recreate it. Useful for software and databases, and close to useless for a reputation built over eighty years.
Every one of them rests on judgment. Two competent valuers can reach materially different numbers for the same brand, honestly, which is worth remembering whenever a valuation is quoted as though it were a measurement.
Why Balance Sheets Understate Them
Accounting rules generally do not let a company put a value on a brand it built itself. The marketing that created it was expensed as it was spent, so a company can have an extraordinarily valuable name and almost nothing on the balance sheet reflecting it.
Intangibles usually appear only when someone buys them. When one company acquires another, the excess of the price over the identifiable net assets is recorded as goodwill, and identifiable intangibles are recognized separately. This produces the odd result that an acquired brand sits on the balance sheet while a self-built one of equal value does not.
Most intangibles are then amortized over their useful life. Goodwill is not amortized under current US rules for public companies; it is tested for impairment, and a large goodwill write-down is an admission that an acquisition did not deliver what was paid for.
To Report or Not to Report
Financial reports are the end product of the accounting process, and they move share prices and determine whether investors and lenders commit. That gives management a persistent temptation, because within the rules there is genuine discretion — when revenue is recognized, how an asset’s useful life is estimated, whether a cost is capitalized or expensed, and how much narrative detail accompanies the numbers.
Two things are worth holding onto. Reporting more than the minimum, including bad news, tends to lower a company’s cost of capital over time, because investors price uncertainty. And the boundary between using judgment and misusing it is where a great many corporate scandals began — not with fabricated numbers, but with a series of defensible-looking choices all made in the same direction.
Why It Matters to a Small Business
If you ever sell your business, much of what you are paid for will be intangible: the customer relationships, the reputation, the name, the processes, the trained staff. The tangible assets are usually the smaller part.
- Register what can be registered — trademark the name, and get intellectual property assignments in writing from contractors, whose work you may not otherwise own.
- Write the processes down, because knowledge that exists only in your head transfers to nobody and is worth nothing to a buyer.
- Document the customer relationships so they belong to the business rather than to a person.
- Reduce dependence on yourself, which is the single largest factor in what a small business sells for.
See also mergers and acquisitions explained and basic accounting terms.