First, we need to understand what is an intangible asset
There are two types of assets- one is tangible and the other is intangible.
Tangible assets are those assets which you can touch and feel. For example, plant and machinery, fixtures, furniture, computers, etc.
Intangible assets are those assets which cannot be touched but can be felt. For example, goodwill, IPR, etc.
Intangible assets are either created or earned. Intangible assets are of two types.
One is finite intangible assets which refers to the assets that are amortised within the period of time. For example, IPR.
Other one is infinite intangible assets which refers to the assets those are subject to impairment.
Intangible assets get valued monthly, quarterly or yearly. Intangible assets can be valued based on three approaches.
Market approach
In this approach, marketable data is collected to compute the valuation of intangible assets. For example, Infosys, TCS, HCL, Wipro, Tech Mahindra are somehow similar kind of companies. If we want to create a lease benefit for all these companies, then we will choose a rate which is applicable to all. If we go for client retention, then it might not be the same for all. Infosys will lead in that case because it has the highest number of existing customers among the examples stated above. Marketable data is taken from the industry as well as cross-industry.
Income approach
Under this approach, we will calculate the income which can be accrued from the intangibles. Suppose there is a company A which acquired company B. Now, company B adapts a software X so what we can interpret from this is software X is surely going to generate income in the books of Company B and it will be considered as a finite tangible in the books of company A. Company A will estimate the year-on-year basis on which the income can be accrued from the intangible. One major problem in this approach is the competition of the cash flow can sync with operational cash flows which makes it difficult for the company to move ahead. Another problem is defining with which yield you need to move forward- cost to equity, cost of debt, etc.
Cost approach
In this approach, we value the cost linked with the intangibles such as depreciation costs, change in technology, etc. Most of the intangibles are technological intangibles here. The Cost Approach works best for companies with assets that have a clear cost, like tech firms with their own software, or companies, but it often fails to reflect the market value or future economic benefits. This method is used when the asset doesn’t make direct money or when other methods can’t be used because there isn’t enough sales data or income information.
Conclusion
Intangible assets include brands, patents, and goodwill. They are much more difficult to price compared to physical assets because they do not possess a set market value. Thus, it becomes important to value such intangible assets since, quite often, they make up a large portion of a company’s worth. Several methods of valuation exist, but the most common approach often involves judgment and guesswork. Accurate valuation is important for any business decision. It guides the handling of mergers and also keeps up with financial rules. The next side of assets for companies is growth and innovation. Companies need to protect these assets as they bring about growth and innovation. In short, it helps businesses plan into the future and stay competitive through their true values.