What is the CIV method and what to use it for?

Key information:

• Intellectual capital (KI) is the knowledge possessed by a given enterprise and is created in the process of its transformation.
• In order to manage KI effectively, one must first be able to measure it skillfully.
• CIV, or calculated intangible value, is one of the methods used to determine KI.
• KI exists when the company's ROA value is higher than the sector.
• The intellectual bonus can be calculated in 7 simple steps.

Details below!

The concept of intellectual capital (KI) is used interchangeably with intangible assets. KI is the knowledge possessed by a given enterprise and is created in the process of its transformation. Nowadays, companies are focusing their efforts on the allocation of intellectual capital in the organization, because through it they can gain a competitive advantage and increase the value of the company.

In order to effectively manage intellectual capital, it is important to be able to skillfully measure it in the first place. One of the measures used to determine value is the Calculated Intangible Value (CIV) method. It is considered one of the best ways to depict the intellectual capital of companies. CIV analysis was developed in the 1930s in the United States for tax purposes. CIV is mainly based on a company's historical data such as financial statements from the last 5 years and ROA values from the same period. If the analyzed company, which has the material assets in question, makes a profit higher than the average profit made in the sector in which the company operates, it means that it has the intellectual capital to realize such excess profit.

The basic assumption in the valuation method under discussion is that intellectual capital exists when the company's ROA is higher than that of the sector. Otherwise, the value of KI is negative - that is, it does not occur in the company. In order to calculate the intellectual bonus, the following 7 steps must be followed:

1. Calculate the company's average gross profit for the last 3-5 years.
2. Calculate the average value of tangible assets at the end of the year for the last 3-5 years.
3. Determination of return on assets ROA - quotient of the value from point 1 and the value from point
4. Verification of ROA values for the sector in which the analyzed company operates - from the selected time horizon.
5. Calculation of excess return, which shows how much more a company earns than the industry average due to the assets it owns. This surplus is obtained by subtracting the product of the industry's ROA and the company's tangible assets from the average gross profit.
6. Determine the intellectual premium by subtracting from the excess return its product and the average tax rate for the last 3-5 years.
7. The final step is to calculate the present value (PV) of the intellectual premium by dividing it by the weighted average cost of foreign capital (WACC).

The value obtained in item 7 is the amount of intangible assets that are not included in the company's balance sheet in monetary units. CIV analysis allows comparison in the area of the sector in which the company under study operates. A declining CIV trend may indicate that the company is too focused on building tangible value rather than, for example, building a brand. Conversely, a rising CIV may suggest that the company has the ability to generate future cash flow before this phenomenon is noticed by the market or even the company's management. The disadvantage may be the assumption of average rather than actual values for calculations as well as the historicity of the analyzed data, which does not take into account future events. In addition, the CIV method is highly susceptible to changes in interest and discount rates. Also, using an average ROA instead of its actual value can distort the real data.

The method of calculated intangible assets is based on verified financial data, which are relatively easy to obtain. This analysis is a useful management tool through which managers can extract important signals about the company's performance. One of the important benefits of measuring intellectual capital is the growth of innovation, and KI itself is often more important than tangible and financial assets owned. Given the long period of time and effort devoted to achieving KI, it is of exceptional importance in an organization.

Adrianna Wojtowicz