There are two important sub-metrics for investors to understand on a balance sheet: net tangible assets and goodwill. Both of these figures make up part of a company’s total assets.
The question here is twofold. Does it matter much if a high number of assets on a balance sheet come from net tangible assets vs. goodwill? And is one preferable over another? As is usually the case in debates like these, I form my approach by thinking through the logic rather than relying on what an author said about it.
Let’s first define these terms. At its most basic definition, an asset is something of value that (usually) produces an income stream. These are typically things like inventory and factory plants, but I say usually because things like cash also count as an asset.
Now, assets on a balance sheet can be either tangible or intangible. A tangible assets refers to one that is physical. It’s the assets we typically think of, like the ones mentioned above. But there are also intangible assets– things a company own that contribute to producing a revenue stream but aren’t physical or have a concrete value.
Examples of intangible assets are things like intellectual property, copyrights, and brand recognition.
Intellectual property can be very significant for a cutting edge technology company who dominates an aspect of their field due to a certain methodology or patent/ manufacturing advantage.
Copyrights can be very important to an entertainment/media company whose revenue is mainly generated from certain shows or movies. The shows or movies don’t have a physical value but produce an income stream.
Brand recognition usually falls under the goodwill category on a balance sheet. This can be significantly important for a food company, whose products are generally indistinguishable in quality from its competitors yet loyalty to a brand leads to an unproportional amount of revenue vs. competitors.
It’s obvious that the reliance of intangible assets to a company’s balance sheet can vary for each company’s unique situation or which industry they are in. So knowing this, does it really matter if a company’s assets are mostly tangible or intangible?
Before answering that question, let’s define net tangible assets real quick.
Tangible assets are everything that are physical and either contribute to the income stream or have an obvious value. In the balance sheet of a company’s 10-k, this is things like cash & cash equivalents, short term investments, net receivables, inventory, long term investments, and property, plant and equipment.
The “net” part of the equation is like the shareholder’s equity of the tangible assets. Basically it’s the number of total tangible assets minus the total liabilities. This number can be negative even when a company’s shareholder’s equity is positive if a high ratio of a company’s assets are made up of intangible assets.
Advantages of High Net Tangible Assets
1. The problem with intangible assets is that because they aren’t physical and have a market value, their true value is debatable. While they may contribute to revenue, it’s not often clear to what extent they contribute to revenue. Because of this, the value of intangible assets must be estimated.
