Human Capital in Financial Statements

Looking through financial statements today it is clear that there is a huge gap between what companies say are their most important asset – people – and what they report in their financial statement – tangible assets, products etc. Financial regulators – such as SEC and FSA – as well as stock exchanges are not much better. They demand certain items to be in the financial statements but not one demand information about people. This is amazing when you consider that more than 80% of the market value of the average S&P500 company is intangible assets i.e. above the book value of a company.

I think a major reason has to do with the fact that no credible standard has been put forward. If a company wanted to show the value of their software developers, sales people and marketing departments as well as receptionists and top managers how should they account for this? By number of people? By total cost of the people? And how do you show investments into this asset base and what about depreciation of it? Does CROIC (Cash Return On Invested Capital) make sense for people or do we need completely new metrics? I just don’t think they know.

Luckily a bunch of really good initiatives are underway to try to come up with standards for accounting for people. An interesting White Paper about this topic can be downloaded here:

I believe it is very important to come up with global standards for financial accountability of human capital. Today it is impossible for investors to have any feel for the quality of software developers at company X compared to company Y. The financial accounts today simply does not begin to describe this important asset base. How should investors and owners understand what they have invested in?

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