Grey Matters: CFO's Third Annual Knowledge Capital Scorecard

BUILDING A BETTER SCORECARD

WHAT ARE KNOWLEDGE EARNINGS and knowledge capital? New York University accounting and finance professor Baruch Lev's methodology for computing these values begins with an estimate of a company's "normalized earnings." That figure is derived from the average of three years of historical core earnings, and three years of consensus analyst estimates as compiled by IBES International. Thus, knowledge earnings reflect both past performance and future growth potential.

These normalized earnings are then compared with the expected rates of return on the company's physical and financial assets as recorded on its balance sheet. In the competitive global marketplace, physical and financial assets have largely become commodities. The expected aftertax returns used in the broad cross-sectional Scorecard are 7 percent for physical assets and 4.5 percent for financial assets. In company- specific measurements, physical and financial assets are adjusted to fair values, and their expected returns are adjusted to company circumstances.

The portion of normalized earnings for any given year that exceeds the expected returns on book assets represents knowledge earnings--the performance contribution attributable to the intangible assets of a company. Knowledge capital is then computed as the present discounted value of all future knowledge earnings. Without a widely accepted expected rate of return for knowledge assets, the average 10.5 percent historical aftertax return of three knowledge-rich industries (software, biotechnology, and pharmaceuticals) is used as the discount rate.

ACROSS THE BOARDS

From aerospace & defense to telecom equipment, industry rankings of median knowledge-capital earnings.

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