Reporting intellectual capital in annual reports can help research-intensive small and medium enterprises (SMEs) secure financial investment, and should become an integral part of companies' reporting, according to a report by a European Commission high-level expert group.
The report, 'Reporting intellectual capital to augment research,
development and innovation in SMEs (RICARDIS)', is the result of an expert
group, set up by the Commission to define intellectual capital (IC), and the
reasons why it is important to research-intensive SMEs. The report also makes
recommendations on how the Commission can help Member States develop
guidelines for and stimulate reporting of this type of information by SMEs.
The report defines Intellectual Capital (IC) as 'the combination of an
organisation's human, organisational, and relation resources and activities.
It includes knowledge, skills, experiences and abilities of the employees, its
research and development (R&D) activities, organisational routines,
procedures, systems, databases and it intellectual property rights, as well as
all the resources linked to external relationships; such as customers,
suppliers and R&D partners'.
This definition is particularly relevant to research-intensive SMEs, whose
activities may not just include R&D, but cut across many other types of
However, when making assessments for funding, SMEs often fail to articulate
these 'intangible' resources and capabilities, which drive value creation.
Instead, information tends to dwell solely on financial accounts, not
including innovation projects or management methods. The report argues that
this failure to provide a full picture of business value is one reason why
SMEs find it difficult to raise finance or equity from banks or investors.
The report recommends including an intellectual capital statement in addition
to the more traditional financial statements. The statement would have two
functions. First, it can act as an internal navigation tool to help develop
and allocate resources - define strategy, prioritise objectives, monitor the
development of the SMEs results and thus facilitate decision-making. Second,
the statement can enable SMEs to better communicate with stakeholders and
thereby attract financial and human resources, and develop relationships.
These benefits are illustrated in a series of case studies that accompany the
report. In one study, investors were asked to generate forecasts for revenues
and earnings for an SME, and provide their recommendations on the company's
stock. The investors were divided into two groups. One group was given the
company's full annual report, including the intellectual capital statement,
while the other group was provided with a version of the report that excluded
all of the quantified non-financial information.
The study found that those analysts given the full report gave a lower
forecast than those given only the financial results. However, those analysts
given the full report were also far more likely to buy, rather than sell
stock. This is because the more information let the analysts develop a fuller
picture, giving them more confidence to invest, despite lower forecasts. This
can benefit the company not only through investment, but also recruitment.
Additional anecdotal evident from the SME found that fund managers and
analysts were reluctant to take intellectual capital information seriously.
However in meetings with fund managers and analysts, the SME found that the
fund managers started to ask new questions, often requesting information that
was already available in the intellectual capital statement.
However, despite the evidence of the benefits of intellectual capital
reporting, companies have been slow to take it up. The report suggests that
this may be due to a lack of awareness of these benefits, as well as a lack of
guidelines available on how to write an intellectual capital statement.
Although some guidelines do exist, the report argues that they are generally
adapted to local circumstances and business culture and differ greatly from
one to another in their terminology and methodology.
Similarly, only a few countries in Europe have sought to make this type of
information a standard part of companies' annual reporting. In Germany, the
accounting standard recommends companies report their intellectual capital in
the management report, although this is not an obligation. Denmark requires
companies to disclose information about their human capital, if relevant to
the economic activity, while in Austria reporting of this capital is now
mandatory for all universities.
The report points to Australia and Japan, where both governments have sought
to develop a common set of guidelines and standards for intellectual capital
reporting. In Australia, the government set up a Society for Knowledge
Economics, which includes the Institute of Actuaries of Australia and
Microsoft Australia. The first task of the society was to develop guiding
principles on 'Extended Performance Management', aimed at the management and
reporting of intellectual capital. In Japan, the government proposed a new
model for the voluntary reporting of intellectual assets. The decision to
publish a Japanese model was motivated by the expectation that this '[...]
will have a big impact in the worldwide trend. Also it may be possible to set
a de facto standard.'
In light of the developments in Japan and Australia, and in order to maintain
its leadership in the field, The RICARDIS report urges Europe to take prompt
action to stimulate the uptake of intellectual capital reporting by SMEs, and
develop global standardisation for this type of information. The report looks
to the European Commission, which it says should take a leading role in
developing common guidelines that may be adopted by Member States at different
speeds and levels.
The expert group makes the following policy recommendations to the Commission
to improve identification, measuring and reporting of intellectual capital:
- establish a European Adoption Task Force that oversees and facilitates the
development of intellectual capital reporting and management in research
intensive SMEs and acts as a learning platform;
- produce a practical guide on intellectual capital reporting for research
intensive SMEs, banks, investors and infomediaries;
- use intellectual capital reporting as a criterion for public support;
- apply intellectual capital reporting as a tool for government agencies;
- conduct further research on new business models' dynamics and the importance
of intellectual capital;
- set up an international standardisation steering group to facilitate the
development of consensus-based standardisation of taxonomies, indicators, and
intellectual capital statements for research-intensive SMEs and help develop
- encourage banks to develop new forms of finance for research based SMEs.