The valuation of brands and other significant intangibles has been controversial since the 1980s when international businesses started to buy national or regional brands and extend them globally. That process made it clear that some companies had significant assets whose value was not shown in the balance sheet and was not reflected in share prices either.
A number of competing models have been advanced to grapple with the measurement problem. A simple one would be to assess the ‘rent’ that can be earned from a branded good. This asks how much the consumer would pay for a branded good, say a Philips long life light bulb (€8 in my supermarket) as against the supermarket’s own brand (€5). The €3 difference, after adjusting for the retailer’s margin, is the rent. You then multiply this by the expected volume over a forecasting period (say five to ten years) and discount to get a present value.
Another way of getting at it is to look for an independent lamp-manufacturing business within Philips (a cash generating unit in the jargon) and look at its income and expense. Once you have deducted direct costs, depreciation for equipment and cost of capital for the tangible assets involved, whatever margin is left can be considered to be the brand value. As before, this needs to be forecast for a period ahead and discounted to give a capital value.
Both of these are approximations, and assume that what is left after deducting observable inputs to the model can only be the brand, whereas a more sophisticated analysis would suggest that there are a number of other potential contributors to this difference.
Brand valuation models look at the current value of the brand, and approximate what it would cost to buy the brand at that time. However, most elements of company balance sheets reflect the cost of acquiring assets at the time they were bought (i.e. ‘historical cost’), not at their current value (known as ‘fair value’ in accounting).
This causes an inconsistency in accounting because only the brands a company acquires in the market place appear in its balance sheet. A brand the company has itself built up over time is not reflected. Its costs have been expensed as incurred and so there is nothing to put in the balance sheet. You will look in vain for Cadbury or Nestlé in their owners’ balance sheets.
Is this a problem? Arguably this is where analysts earn their money, by pointing out value drivers not visible in the balance sheet. Also the balance sheet is not expected to show the current value of the company’s assets. Standard-setters see it as an inconsistency, but have more important inconsistencies to occupy their minds.
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