Fast forwarding to innovation

The words creative and accountant will no doubt be met with sniggers by some and disapproval by many. Yet one of the hottest issues in the accountancy profession today is how financial statements fail to account for the true ‘market’ values of today’s knowledge-based organisations.

The traditional accounting model is accused of being outmoded and unable to keep up with today’s fast-paced business environments where the currencies of value are intangible assets such as creativity, innovation, employee skills, culture and relationships.

In the 1980s, the key differentiator was higher productivity, achieved through the adoption of lean production methods pioneered so successfully by Japanese organisations.

Accelerated innovation in 2000
In the 1990s, it was faster time to market. In the 2000s, the key differentiator and source of competitive advantage is accelerated innovation, achieved through business practices that promote creativity. The resulting innovations not only relate to products and services. They also cover the work processes and organisational structures that underpin them. In knowledge-based organisations, creativity and innovation help drive shareholder wealth through the creation of value for customers.

It is still not possible to assign a monetary value for most internally generated intellectual assets. These assets, and how they contribute to competitive advantage, need to be appreciated so that the right investments can be made to enhance them. The finance function can play a key role in managing these knowledge assets and understanding and reporting this source of enterprise value.

The new OFR, proposed by the company law review, is intended to provide information and analysis of the business of a company in terms of its invisible assets, which although not normally accounted for, affect future performance, including an account of relationships with key stakeholders and information on intellectual capital.

Reporting predictive information
The new model of reporting proposed involves reporting predictive as well as historic information on performance. The increasing use of intellectual capital statements by some leading companies such as Skandia has been driven by the decreasing relevance of traditional financial statements.

The new business environment is an opportunity for accountants. Their traditional background involves measurement and predisposes them towards new types of measurement systems that also emphasise non-financial performance measures.

If the finance function is to enhance internal decision-making as well as to give the outside world an understanding of an organisation’s value and potential, it must address a number of problems in capturing the drivers of value in organisations. Only by understanding each of these can we begin to develop a solution.

Attempts at classifying and valuing intellectual and intangible assets in a universal way have hit problems because knowledge is context dependent and intangibles are dynamic rather than fixed objects. While labelling intangibles helps managers think about each one in the context of their organisation, an organisation’s knowledge does not itself have an intrinsic value. Assessing how knowledge is applied around the organisation is the key to understanding the value of intangibles.

Having the right strategy
Creating value for customers and sustainable competitive advantage relies on having the right strategy to exploit knowledge and innovation. A misdirected strategy could lead to poor performance in the future. An intellectual capital report, for instance, risks valuing non-value generating ways of working as well as ones that could hold the key to future prosperity. Crucially, an intellectual capital statement may not indicate whether the organisation can reconfigure and adapt to its fast-changing environment and circumstances.

Particular intellectual assets are inherently hard to measure. This causes two problems. The first is that measures designed to enable the management of intellectual assets are often limited. Let’s take creativity as an example. Typical measures of creativity and innovation used in organisations around the world are: the proportion of income from new product introductions; the number of new product innovations; and the average length of time for product design and development.

Indirect measures are precarious
Such output measures, however, focus on product innovations and not the benefits of process and organisational innovations. A number of indirect measures are often used but their implementation is precarious because creativity is not a logical sequence of knowledge creation. The overuse of measures leads us into a second problem, a paradox which will be explored in the results of an international research project commissioned by CIMA to spearhead CIMA Global Business Management Week. The survey, Harnessing Creativity to Improve the Bottom-Line, contains the views of 800 senior executives across five continents.

The paradox has arisen through the collision of two trends. Growing demands of shareholders, regulators and customers have led to an increase in benchmark standards and greater expectations of year-on-year improvement. At the same time, there is an equally strong demand for creative applications to achieve these results. Meeting the necessary benchmark standards requires rigid work processes and controlled environments. Yet these rigid processes and controls can stifle the very creativity that can deliver breakthrough ideas or innovative ways of working, and therefore may destroy shareholder value.

Reporting an organisation’s source of value must take into account some basic rules:

• data should meet a consistent standard for monitoring performance both over time and for benchmarking purposes.

• a system must provide data for management to identify the likely effect of their actions on all stakeholders.

• ways need to be examined in which the finance function can facilitate, rather than hinder, creativity.

And most importantly, there must be a clear link from the measurement and management system to the strategic targets of the company.

The finance function will continually need to look at ways of reporting more effectively and accounting for the value generated from intangible assets. Undoubtedly, this will involve using predictive non-financial data, more approximations and creative presentation.

• Stathis Gould is CIMA’s head of technical issues.