In the business world, two broad categories of goods exist: tangible and intangible. These two types of goods receive different accounting treatments as well as different considerations during crucial transactions such as mergers and acquisitions.
The Accounting Definition of “Tangible Good”
Tangible goods or tangible assets occupy most of the attention of accountants. Humans can interact with tangible assets in a physical sense. These physical assets often have a shorter useful life compared to intangible ones. Examples of tangible assets include some of the following examples:
- Computer equipment such as those used to operate a business headquarters or office.
- Fixed, long-term machinery such as those used in the production process at an automobile manufacturing plant.
- Software and other digital products sold or used by businesses.
- Natural resources such as gas, oil, and minerals.
- Manufacturing overhead supplies like glues, nails, and other miscellaneous items.
- Physical products sold by retailers to the public, including food, medicine, and disposable products.
- Inventories used by both retailers and manufacturers to generate profits.
- Retail storefronts such as a spa treatment facility.
Of course, there exist an incredible number of different types of tangible goods. Accountants typically make use of conservative principles to value tangible assets at either the lower of their original cost or the current market price.
Examples of intangible goods, on the other hand, include:
- Patents: Governments grant patents to individuals and businesses to protect their intellectual property rights for a defined period of time.
- Goodwill: When a business purchases another business, goodwill often comes into existence as a result of the transaction. It accounts for the excess cost built into the transaction.
- Licenses: Governments and other firms also grant licenses and permits to businesses to operate in a certain, regulated manner.
- Trademarks: Companies protect their intellectual property and brands with trademarks granted by the government.
- The Company’s Brand: A brand itself, including wordmarks, logos, and “voice” function as intangible assets.
- Intangible Products: These products could include consulting services or creative works such as movies or music.
Characteristics of Tangible Assets
Tangible assets tend to require additional measures such as security and insurance since they exist in the physical world. Businesses that transact primarily in tangible assets will also need to make different financial decisions compared to those which principally deal with intangible goods and services.
Current vs Noncurrent (Fixed) Assets
Within the category of tangible assets exist two subcategories: current and non-current or fixed assets.
Current assets include those assets which exist for a short time on a firm’s balance sheet, including cash and cash equivalents, short-term investments (those which a firm intends to convert to cash within one year), working capital such as inventories and accounts receivable, and prepaid expenses like insurance or prepaid rental contracts.
Noncurrent assets include those assets which lack liquidity and for which the firm cannot convert to cash in a reasonable amount of time. These include property, plant, and equipment, land, long-term investments, and vehicles such as commercial trucks.
Comparing Tangible and Intangible Assets
Key differences between tangible and intangible assets include:
- They receive different accounting treatments:
- Companies often route tangible goods through the balance sheet prior to the income statement.
- Intangible assets often appear first on the income statement as an expense line item.
- Tangible assets have a greater susceptibility to damage and theft.
- Intangible assets pose valuation difficulties for investors and lenders, whereas tangible assets have settled accounting techniques.
Examples of Companies with Substantial Tangible Assets
To compile this list, we examined the largest industries in the United States ranked by the total amount of property, plant, and equipment (PP&E) held on their books:
- Power Utilities: Utilities and power companies must make massive investments in infrastructure and other fixed assets. The capitalized value of these assets sits on the balance sheet for long periods of time.
- Retail: Businesses which sell merchandise have large sums in their working capital accounts under the current assets section of the balance sheet.
- Auto and Truck: Automotive manufacturers and dealers must contend with large amounts of tangible assets.
- Semiconductors: Firms like TSMC must make large capital investments in fabrication facilities and manufacturing plants.
- Telecommunications: Telecom firms must invest in significant amounts of fixed infrastructure like towers, wires, and machinery to support the operations of the firm.
Examples of Companies with Substantial Intangible Assets
The following companies have a large amount of intangible assets as measured by various studies:
- Apple: No surprises here. Apple has developed tremendous intangible market power over the last two decades thanks to its late charismatic founder and innovative, category-defining products.
- Amazon: In addition to a vast sum of tangible assets, Amazon always carries tremendous branding power.
- Microsoft: While Microsoft has a large amount of assets carried on its books thanks to its array of data centers and marketable software products, the company also invests significant sums in research and development.
- Alphabet: The holding company of Google also invests in a variety of so-called “moonshot” projects designed to
- Tesla: Elon Musk’s company may have substantial property, plant, and equipment, but the company pays for no advertising since it has built large amounts of intangible brand equity thanks to its founder.
Valuation Differences Between Tangible and Intangible Assets
For businesses with a high degree of tangible assets, the task of valuation becomes considerably easier. On the other hand, a business with a large amount of intangible assets may pose valuation difficulties for lenders and investors attempting to value the company.
Aswath Damodaran, a professor of finance at New York University’s Stern School of Business, prepared a whitepaper on how to value companies with intangible assets. This paper communicates the following valuation principles for analysts seeking to better understand how intangible assets create value for shareholders:
- Damodaran points out that firms with high-value intangible assets often have high amounts of spending in research and development, advertising, and employee recruitment. These income statement line items receive the “expensed as incurred” treatment by the accounting profession which then understates the value of the intangible assets created by those efforts.
- Manufacturing firms, on the other hand, create capitalized assets on the balance sheet when making large investments in fixed assets such as property, plant, and equipment. Thus, book value appears more closely related to the actual value of the firm.
- Firms with significant intangible assets have a wider discrepancy between their book values and true enterprise value.
How Businesses with Tangible Assets Operate Differently
A business with significant amounts of tangible assets tends to operate in the following ways:
- Common income statement expenses include depreciation and amortization, cost of goods sold (COGS), and interest expense since these firms tend to use debt to fund large fixed asset purchases.
- They tend to have large amounts of current assets such as inventories and accounts receivable.
- Businesses with significant tangible assets may invest greater sums in security and storage of their physical goods.
- These businesses may require more staff to run operations at an efficient level.
- These firms may have lower valuation multiples due to the degree of investment capital required to grow operations.
Why This Matters for Your Business
As a business owner, you should think carefully about how to run your operations based on the types of assets held on your books. For business owners with mostly tangible assets, everyday operational considerations include maintaining sufficient cash flows to sustain those physical assets, securing assets from theft and damage, and carrying sufficient insurance policies to cover possible damaging scenarios.
For business owners operating in the intangible space, other considerations arise, including the need to communicate the value of those intangible assets through financial metrics which investors and lending institutions alike can understand such as free cash flows to the firm, gross margin, and measures such as EBITDA and NOPAT.
The key principles of entrepreneurship remain: creating value and communicating that value to outside parties, whether the business focuses on tangible or intangible goods.