Your company’s balance sheet is incomplete until people are valued as financial assets
By R. Paul Herman
What is your organization’s most important asset?
CEOs often respond that the organization’s people are its greatest asset. But if this is true, where are people accounted for in the financial statements?
Today, people are generally classified as expenses on the income statement and liabilities on the balance sheet— not as an investable asset. Thus, when CEOs seek to increase profit, they cut costs—like people—rather than investing in assets—like people—that can appreciate.
“The most valuable assets of a 20th-century company were its production equipment,” said management guru Peter Drucker in 1999. “The most valuable asset of a 21st- century institution, whether business or non-business, will be its knowledge workers and their productivity.” Drucker’s prescient observation clearly highlights the reality that a majority of corporations face in today’s “knowledge economy.”
Intangible assets—patents, intellectual property, brands, and research & development—are all created by people, and they are the core contributors to profits and shareholder value. In fact, investment advisory firm Ocean Tomo estimates that in 1975 more than 80% of the value in the S&P 500 firms consisted of tangible assets—like land, plant and equipment. By 2010, approximately 80% of the S&P500 market value is attributed to intangible assets. But, today’s accounting systems and financial reporting are still using 20th century definitions, creating a “gap in GAAP” (the Generally Accepted Accounting Principles) on how value is created in the 21st century.
The overarching goal of financial statements is to attempt to accurately depict the economic reality of a company and to provide users with relevant information that is going to enable investors to make sound decisions regarding their investments. A reporting system that fails to provide information on the core aspect—more than 80% of the stock price value—of a company’s ability to create value is missing the mark. People invent products (like Apple’s iPad), and people serve customers (like Zappos). Teams of people work with networks of suppliers (like Walmart) that make goods and provide services, yet all of this value is under-accounted for because people are an “invisible” asset—and one not quantified at that.In academia, researchers are linking intangible value to a company’s profit and performance; you can find many of these papers at www.SRIstudies.org. Alex Edmans of the Wharton School at the University of Pennsylvania found that the stock market does not fully value information about intangible assets, including employee satisfaction. Professor Edmans analyzed Fortune magazine’s annual “100 Best Companies to Work For in America” lists from 1998-2010 and found that a portfolio of the publicly- listed firms consistently outperformed the standard benchmarks.
Let’s bring financial statements into the 21st century. Get your company to follow the lead of companies like Infosys and Tata, and begin to quantify the value that people add to your organization. Currently, there are no firms in the U.S. or European companies reporting this calculation publicly to investors. This powerful, transparent reporting on all the assets of a company has the potential to be a catalyst for developing a set of best practices that will provide a reliable methodology for the measurement and valuation of intangibles. When this eventually happens, CEOs seeking to increase shareholder value should be more apt to spur investment in — and not so easily lay off — the core creators of value in their business: the people. It is only then that CEOs can be truly authentic when they herald that “people are their company’s greatest asset.”
(R. Paul Herman is CEO of HIP Investor Inc. Former HIP analyst Tom Bowmer contributed to this feature. Details and full disclosures are at www.HIPinvestor.com)
Posted March 9, 2015 in 25115