Accounting may give you the answer. Really. The world of debits and credits is changing. You can use those changes to better manage and explain your business.
Explain that hole in your stockholder equity or apparent shortage of total assets on your balance sheet. Show how your operating losses since beginning the business are actually positive.
When you first formed your business with cash and other contributions, the balance sheet accurately reflected what your business was worth. But right after inception, the value of your business and the balance sheet parted ways. With more business success, the balance sheet will lag behind what your business is really worth.
Thanks to a shift in the accounting paradigm, accountants can now recognize and quantify intangible business assets. As an entrepreneur, you can use this knowledge to evaluate the kinds of intangible assets you are creating in your business.
You can identify how costs that you are required to report as expenses are actually building assets and value in your business. You can explain that deficit in net worth.
Your blue sky is definable.
Although your accountant does not yet require you to reflect the values of intangibles as they are created, understanding them as you grow your business will support not only proper amortization of assets over time, but also help you optimize your exit strategy.
Defining blue sky
Intangible assets are often the product of sweat equity and ingenuity in building your business. Historically, when businesses were sold, they would sell for net asset value plus an amount for this “blue sky.”
Until 2001, the difference between the value of what a buyer would pay for your business and the measurable tangible assets was simply tossed into a category called goodwill. Accountants made you define your tangible assets so they could properly depreciate them, but they arbitrarily amortized goodwill over a period of years. There wasn’t a lot of thought about whether or not such depletion of intangible assets was correct.
The Financial Accounting Standards Board (FASB) changed how businesses can define intangible assets with the Statement of Financial Accounting Standards 141 and 142.
In the Statement of Financial Accounting Standard 141 there is a schedule of potential intangible assets in your business. These are best described with the acronym MACCT. That stands for Marketing, Artistic, Contract, Customer and Technology.
If you survey your business using MACCT, you’ll discover many potential intangible assets in your business. For example, what is unique and proprietary about your marketing processes? It could be such things as the design of your Web site, campaigns you have developed or project management systems.
Do you have protected music, art, books, or other artistic aspects of your business? These items should be broken out under artistic intangible assets on your financial statements to demonstrate as well as measure their financial value over time.
The same is true for contractual agreements that you have with other vendors or service providers such as a below-market-rate loan or office lease. A customer base that provides recurring revenue can be defined and measured under MACCT as well as proprietary software and other technology designed to support your business.
Other intangible assets may include your logo, brand names, advertising jingles, trademarks, newspaper mastheads, domain names, noncompete agreements, water or mineral rights, databases, secret formulas, franchise agreements, production backlog or even photographs.
A key to your intangible assets is to look for documentation, such as a record of your cost to produce it. How much would someone else have to pay to replicate what you’ve created? Also consider the potential value to a buyer if you sold that asset separately.
Think about how McDonald’s has created value for its franchisees by fully documenting the? operation of each restaurant. With this proprietary system, a new buyer can begin business with few problems. All franchisors have manuals for operations, marketing, and numerous other aspects of their business. Your business may have similar assets.
Can assets be sold?
After identifying any such assets, determine if they can be sold, licensed, exchanged, rented or transferred separate from the business. I use the acronym SLERT.
If so, it is likely they would be capitalized in a purchase price allocation and recognized for the value they have. This is good news when the time comes to sell or exit your business, but also when you need an influx of capital for growth right now.
Lenders or private equity investors will be able to see this blue sky value by the adjustments you make to the financial statements.
The assets for each business will be unique, so it is important to discuss them with any partners, accountants and other advisers who help prepare your quarterly financial statements. Start tracking these blue sky assets this quarter to profit from your sweat equity and ingenuity in the near and distant future.