Balance Sheets - Embedded.com

Balance Sheets

Read any software company's 10-K statement to the SEC. Long tables list the companies’ assets and liabilities. Droning paragraphs give managements’ analysis of the data, prospects for the future, and excuses for past performance.

The profit and loss statement is always interesting as it describes where the money went over the last quarter or year. But the real meat lives in the balance sheet, an accounting of the company’s current net worth. It starts with the assets – cash, investments, goodwill, buildings, furniture and equipment, and then describes liabilities.

But there’s one thing missing, one thing that has more value than the silly desks, chairs and oh-so-rapidly depreciating PCs that are part of the “furniture and equipment” category: IP. Isn’t it astonishing that accountants still view software and other forms of intellectual property as valueless?

How much is Windows worth to Microsoft? If their entire campus were torched, if every physical asset disappeared in some cosmic joke of fate, they’d survive. But if that same fate befell their IP, if Windows’ source code disappeared, they’d likely fail.

Windows is worth billions, maybe hundreds of billions to that company, yet no accountant recognizes its value. They’re too busy toting up the cost of the stationary.

What about Cisco’s ASIC design files? Even Michael Jackson tracks the value of his Beatles songs, mere bits stored on tapes or CDs. Yet Apple’s iTunes library and iPod designs have, according to standard accounting practices, no value. How are those bits different than the ones organized by Lennon and McCartney?

At most companies inventory lives behind a locked fence. A stern-faced clerk makes you sign for every part. Want a tenth-of-a-cent resistor? Fill out the form. In duplicate. But inventory is itemized on the balance sheet, so accounting insures that asset is as protected as the business’s cash balance.

Yet IP often lives on uncontrolled servers, vulnerable to angry employees and acts of God. Or simple typos. I remember entering rm –r once and a second later having that “oh no!” moment.

If the balance sheet listed IP all source would live behind some virtual locked fence, guarded by a dour-faced clerk or unfriendly bit of software. And that might indeed be a good thing. Over half of us don’t make use of even the most minimal sort of configuration management, so we routinely experience expensive problems.

The NEAR spacecraft failure was partially attributed to a CM issue – they launched the wrong code! Two versions of the 1.11 flight code existed; one was tested, and the other was used. The FAA announced in the late 90s they lost all of the code to control flights between Chicago O’Hare and the regional airports. No one used a version control system and an angry employee purposely deleted it all.

If CPAs tracked IP they’d quickly understand the ethereal nature of software and other designs, and they’d quickly learn how a single transient can wipe out most of a company’s value. Petty pilferage of inventory would drop to a side issue as they designed robust backup strategies.

And that might be just what we need.

Uttering the words “it’s just a software change” would become a firing offense. Mention a quick upgrade and the accounts would gasp “you want to do what? Do you have any idea of the value of that asset you plan to desecrate?”

Track the real value of software and the accountants will complain bitterly to upper management when impossible schedules threaten to wreak havoc with the code. Maybe – just maybe – estimation would become a real process respected by everyone. After all, no CFO will permit management to raid cash coffers unless there’s a demonstrated need. They require a disciplined cash management strategy, one recognized by the SEC and their own accounting board.

Track the value of IP, and the only companies abusing their code will be the Enrons, social outcasts doomed to fail.

Jack G. Ganssle is a lecturer and consultant on embedded development issues. He conducts seminars on embedded systems and helps companies with their embedded challenges. Contact him at . His website is .

Reader Response


I agree that IP is undervalued . . . sort of.

A company I recently left is now shutting down completely. As they were winding down, they were trying to sell “design licenses”, including source code, documentation, GUIs, schematics, etc., for a mere $35K, and they weren't getting any bites. Yet this small startup will probably get several hundred $K for their “hard” assets (test equipment, etc.). $35K seems like a bargain for 20+ man-years of effort (a design that, by the way, works quite well, and does exactly what was intended). Yet there are no takers. So what's the IP really worth?

– Harold Graham


Intangible assets such as IP are reflected in the stock price. Most companies' stock prices are not the same as their asset values listed on their balance sheets. Also, another measurement of IP is “Goodwill”, the amount of $ beyond a company's assets (on its balance sheet) that another company is willing to pay to acquire the company.

– Art Felgate


Intellectual Property (IP), Codifed Thought . . . don’t companies pay thousands of dollars to have their IP registered? It should have value, but over time that IP decreases because some other company is developing a better IP–that's the nature of competition! Maybe IP isn't listed on the Balance Sheet because there is no reference point to establish a value for that IP. How do you nail down the actual cost of IP? You can't! You'd need to compare the IP of one company against another to establish a cost value. But once you do that, the company with the better IP wins, the other looses. The comparison of one IP to another IP destroys the inferior IP–this called the Heisenberg Principle. So the value of an IP is left in its secrecy or implied value. An implied value cannot be listed because there is no concrete reference point. And again, like the Heisenberg Principle, once you try to compare two similar IPs–only one IP has value. Companies don't want to risk that, if they did, the economic invisible hand would gravitate to the only IP of value.

– Steve King
Engr.
Kaman


You got it right. It's not just code–it's schematics, configuration drawings, user manuals, etc. Our company, even though founded by and still very much run by engineers, still does not consider our IP nearly as important as they should. The only value they see is inventory. It's funny–the only thing they value is stuff that has been manufactured. They totally ignore the ABILITY to create more wealth!

– Andy Kunz
Transistor Devices
Sr Firmware Engr


Jack,
You have, once again, characterized the incredible misunderstood life of the software designer. I had the pleasure of meeting you when upper management of my last employer began to recognize the value of software. We hired “big gun” Jack Ganssle to come out, give the Better Firmware Faster talk, and tell us we were embarking on a major challenge. Still, the Marketing folks smart enough to know that software is worth something insisted on optional features valued on the Bill of Material at pennies so that the box full of silicon and such can have a healthy margin when poor customer X pays up because of what the software does for them. Worse yet, the salesman's best buddy at customer Y gets our best efforts for nothing because of volume. In the end, our best efforts are bargaining chips. Bells and whistles that the sales force uses to make the quarterly goal. If the accountants could value bits and bytes they would finally realize that “Software is the most expensive thing in the universe”!

– Bill P


Hello,I agree with that balance sheets do not directly state value of IP.

But in my opinion sales figures are an indicator of IP. In the normal course valuable IP leads to good sales and profits.

The balance sheet needs to be very objective, adding IP to it makes it subjective and improper accouting may be even harder to catch.

– Sateesh K


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