You've heard your CEO say, "Our employees are our greatest asset."
But if you've reviewed company financial statements recently, employees are not technically classified as assets -- or valued that way either. In official accounting terms, people are regarded as expenses (i.e. salaries) on the income statement and appear as liabilities (i.e. pensions) on the balance sheet.
R. Paul Herman, CEO of HIP Investor, which manages money for investors seeking sustainable portfolios, disagrees with this assessment of a company's employees. When a manager needs to boost performance, he can increase profit by reducing expenses through layoffs. Yet if people were accounted for as assets, they could be less likely to face the ax in a downturn, because managers would invest in their assets that can appreciate in value over time.
HIP Investor has uncovered a handful of companies in high-growth Asia that currently are valuing their employees as assets and reporting on them in their financial statements. HIP is seeking to re-ignite a movement to invest in people, while also upgrading corporate financial statement approaches.
I asked the HIP team to explain to me how this might actually work, because in order for human capital to be accounted for differently, standards like U.S. GAAP (Generally Accepted Accounting Principles) might need to change.
"First of all, you need to understand how the economy has shifted," Herman said. "Tangible assets (i.e. real estate and physical equipment) are not driving performance like they once did. Intangible assets (i.e. patents and brands) and the people that create them are now the main source of value."
In 1975, for example, tangible assets made up 83 percent of the S&P 500 market value. In 2010, this had completely flipped, and 80 percent of the S&P 500 market value was attributed to intangible assets. Inventions by people are core drivers of today's economic engines of business -- and Herman mentioned a few investment funds that focus on this theme.
Next, Herman explained that a reporting system that "fails to provide information on the core aspect -- more than 80 percent of the stock price value -- of a company's ability to create value is missing the mark. People invent products (i.e. Apple's iPad), and people serve customers (i.e. Zappos). Teams of people work with networks of suppliers (i.e. 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." (The HIP team explains more in this Huffington Post feature.)
I fully agree. Human capital should be on the balance sheet as an asset, or at the very least reported as supplemental information in the financial statements. Intuitively, it is easy to grasp that with training and experience an employee's value to a company does appreciate over time.