Posted by: DrAlanRae | January 24, 2008

Growing value in your company

When I was working for the Business Link and had the leisure to think about things like this I got interested in what Knowledge Management might mean in practice for a small organisation. I came to the view that its about building a structure that you can control that keeps the right balance between sales and delivery while gradually bootstrapping up the amount of re-sellable know-how. But the value lies in the structure.

So – successful companies build a formal systematic structure to achieve a defined set of income streams which are worth acquiring. And that’s how they maximise the value of the company.

buildingValue

What incoming purchasers or investors are interested in is whether there is a systematic means of generating profits which relate to

• A real customer need
• An unfair advantage
• A team that can deliver the results by remote control

However it has been calculated that only 15% of the value of a company appears in the balance sheet – the rest is intangible value – this used to be called ‘goodwill’ in the UK. For a publicly quoted company, the intangible value is the difference between the book price and the share price. For private companies it’s more difficult, but we can be sure that the intangible value lies in 4 main areas.

• Knowledge in people’s heads – skills and tacit knowledge
• Formal intellectual property rights – copyrights, patents, trademarks, brand equity etc. We might consider this together with the development of new products and services as a focus on innovation
• Customer related information and relationships
• Business processes.

There is also the knowledge and systems that comes from interacting with other organisations. If all of these are coded and formalised, then a financial justification can be made for the value created in the company.

The thought leaders in measuring the growth of intangible assets in a business are probably Skandia who for some time have been publishing such measures in their balance sheet. They follow the principles of the balanced score-card which identifies

• An innovation focus
• A people focus
• A customer related focus
• A systems/process focus
• Which leads to a financial focus
.
It’s important to catalogue formal production of Intellectual Property Rights (IPR) in a business including the growth of Research & Development. One method of accounting for this is to capitalise the value of salary spent on R&D and amortise it over 2 years. IPR includes the value of Patents, copyrights and Trademarks.

Another useful measure is how much business comes from new goods and services. In the UK, the Small Business Service commissioned a benchmarking study from the Cranfield Management Institute. The UK median for all service companies is 8% Top quartile figures is 22%. This gives you a quick way of establishing how well you are doing in comparison with your industry.

People is the next area to measure. You need to monitor their skills and how happy they are in their work situation.
Fortunately for the smaller business, research shows that staff satisfaction correlates very strongly with absenteeism and accidents. These are normally measured as a legal requirement so tracking this becomes easy.

Skandia developed a human capital index that measured the people-based intangible assets in two of the group companies on a range of criteria. The results are reported in their annual report and accounts.

The amount of money spent on training or the number of graduates in a company is a good proxy for the growth of people skills in the business. In the UK, the number of graduates in a company has been found to correlate strongly with the degree of internet connectivity in the business.

Process measures generally concern themselves with efficiency and IT. An outstanding business will make sure that its systems keep pace with its marketing activities. Measures here need to relate to the operational realities of the particular business. Measures that Skandia used included contracts / employee, administrative costs / sales turnover and IT costs / administrative costs.

In today’s world this investment needs to fund internal processes, sales order processing, communications with customers and external communication and sharing data with collaborators, customers and suppliers. This situation is illustrated in the following diagram.

For most of us, it’s important to be able to focus on measures of business efficiency that we can readily track. We recommend that you measure Gross Value add per employee and the number of debtor days. These should come directly from your accounting system and will give a real handle on your operational performance and improve your cash flow.

Customer focus is where the real benefits from knowledge management for a small company can be gained. You need to have some measure of customer satisfaction, and this can be tracked by the number of complaints received per customer.
Prospective purchasers buy a secure income stream.

You need a systematic way of recording and analysing this information. An effective customer database allows you to manage this without great time or cost implications. We suggest you monitor the proportion of business that comes from new customers.

The Harvard Business Review estimates that natural wastage results in the average company losing half of its customers over a 5 year period. The average company just manages to replace this. So it’s critical to measure how well you’re doing.

To really be on top of your business, you should know what volume of enquiries you need to generate and what proportion of your business comes from new sectors, new products and new customers. It’s critical to be able to readily know which the most profitable areas of the business are and which the best types of customer are.

Getting to grips with this means setting up the chart of accounts in the financial system so as to easily highlight meaningful divisions of the company. It is a tragedy that in the UK, the vast majority of accounting systems are set up using the default chart of accounts that comes with the software.

Financial Focus is about how well the company is doing and concentrates on profitability and liquidity. Many ratios analyse profit and loss and balance sheet performance. Skandia companies tend to use operating profitability and return on capital employed. In our Benchmark sheet we suggest 3 measures, Pre-tax profit / turnover, Return on Capital employed and the Acid Test Ratio.

This last is a balance sheet ratio which measures the degree of solvency of a company. It is a more critical version of the current ratio which divides current assets by current liabilities. The Acid Test Ratio divides current assets – stock value by current liabilities to measure how liquid the company would be in an emergency.

Cranfield also track cash in the bank as a % of company turnover. The median value for service companies in the UK for this indicator is 3% and for the transport sector is 2%. For top quartile companies it’s 14% and 6%. You can track the growth of value in the company via development of knowledge and intangible assets by using the measures in the table below.

ValueTable

So there you are that’s how I see it based on a combination of study, prejudice and experience.

I find it fascinating that so few people are interested in engaging with this while everyone has an opinion on marketing. What do you think chaps – does it make sense?

Alan

This article is cut down from a chapter I wrote for the e-Tranee workbook – an EU Leonardo project to help e-enable small transport companies in Eastern Europe. This accounts for the transport industry section of the table You can download the whole chapter here</a>.

Copyright Alan Rae 2008

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Responses

  1. Loved it! Lots of sense, here, and in sensible language. Applicable to things like Penny On (The Penny On Trust), too, Alan.

  2. thanks Jeremy – always nice to know that it’s seemed useful to somebody else!. As you say, it’s quite generic and applies equally as well to not for profit organisations


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