Book value accounts for about 20% of a company’s market value today. The rest – 80% – is down to immaterial ‘assets’. This makes valuing companies very difficult indeed.
There are many good reasons why book value always will be lower than market value. However one way to close this gap – and thereby making the value more transparent – is to capitalize more of the immaterial value. This could be ‘Brand Value’, ‘Customer Loyalty’ or ‘Innovation’. All of these things obviously makes a company worth more. However, one candidate stand out to me – people or ‘Human Capital’.
Why ‘Human Capital’ is a strong candidate is because it accounts for the bulk of the cost for most companies today. For some it is about 75% of total costs. It is also universally recognised, that people and their ability to perform, is the single most critical reason behind value creation today.
How practically this should be done is quite difficult to say. One way is to capitalise the total cost of the people including wages, pension, recruitment, training etc. But many questions are difficult: Should people be depreciated? If you spend money training them, should this be capitalised as any other investment? What happens when somebody leaves – should a cost be booked on the income statement? Can you ‘buy’ people below their value and should this be a gain on the income statement? How do you measure the value of people (if you don’t just use the cost base)? Some people are clearly worth different to the company despite perhaps getting the same pay – how should that be accounted for?
Perhaps these questions illustrates why Human Capital is not capitalised today. It is simply too difficult to find a meaningful way forward. But I would like to see a good, public debate about this. Perhaps there is a way?