To summarise the Harvard Business Review article, "Why financial statements don't work for digital companies": Uber, Twitter, LinkedIn and WhatsApp are all loss-making companies, but they have very high valuations. It seems that investors disregard financial statements when valuing digital firms. The traditional financial accounting model does not capture the main way that value is created at digital companies, which is increasing return on scale of intangible investments.
Intangible assets are assets that are not physical, and are therefore more difficult to value than tangible assets. Examples of intangible assets are brand, intellectual property, supplier networks, customer relationships and human capital. The balance sheet under traditional accounts-based reporting methodology does not reflect the true value of intangible assets, and, therefore, will not accurately reflect the value of a company whose value is largely dependent on intangible assets.
There is an important distinction between intangible assets of digital companies and tangible assets of traditional companies: intangible assets of digital companies increase in value with increase in use e.g. more users on a social network increases the value of a company and the more customers using a technology platform increases the value of a company. With traditional companies, physical assets decrease in value with increase in use.
Out of the companies listed on the London Stock Exchange, we thought that Just Eat was one of the companies that this thinking was most applicable to. Just Eat is an online food order and delivery service, acting as an intermediary between restaurants and its customers. In its last financial year, Just Eat made a £100 million loss and its net assets were valued at £730 million. The market capitalisation of the company is £5.8 billion. Clearly, the value of its digital platform is not captured in the financial statements.
The fact that the financial statements do not capture the true value of intangible assets demonstrates the importance of good communication in the Strategic Report, in order for investors to correctly value the company.
Some areas of consideration when discussing the value of intangible assets in the Strategic Report:
By understanding how the valuation of internet companies is not captured by the financial statements, it demonstrates the need for all companies to include detailed narrative reporting around the financial statements.