We often see the phrase “People are our most important asset” on conference room walls, in company policies, annual reports, and frequently repeated by many so-called leaders. But can they prove it where it really counts—on their financial statements? Unfortunately, traditional GAAP and IFRS accounting make this very difficult.
Many assets have clearly defined financial values. Cash and cash equivalents are obvious. Land, buildings, and equipment can be added to the balance sheet based on their original cost. These assets depreciate over time based on set standards, such as 30 years for buildings and 1-10 years for equipment, depending on the type. Some assets, like real estate, can be adjusted for appreciation based on market analysis. These assets can then be categorized as current or long-term based on their liquidity.
Some assets are more esoteric, and their financial value is harder to determine and defend. Goodwill and brand value are examples. There are standardized methods to assign financial value to these, and it can be argued they are legitimate because the value of brands like Apple or Starbucks makes the company more financially valuable to investors. However, analysts are deluding themselves if they believe a 10% swing in goodwill or brand value is as accurate as a comparable swing in cash or receivables. Yet both impact the equity line equally.
While an asset is on the balance sheet, further cash investments may be made to add or maintain its value. These expenses on the profit and loss statement can sometimes be moved to the balance sheet to adjust the asset value. As a balance sheet asset depreciates, the reduced value is moved to the P&L as an expense. If an asset with remaining value is disposed of, the remaining value is also moved to the P&L as an expense. This forces a company to consider asset utilization and the cost of removing an asset compared to the value of a new process or asset. There’s always a balance between asset value, expenses, and investment, even with underlying assumptions on rates of change driven by GAAP.
Now, let’s go back to people. Remember, people supposedly are “our most important asset.”
The expense of people is clear on the P&L, shown in salaries, benefits, and so forth. These expenses can be assigned to products using methods such as absorption-based cost accounting, which some organizations mistakenly believe is accurate and useful for decision-making, or value stream costing in more enlightened financial management.
But where are people on the balance sheet? Where is the asset that so many organizations talk about? It’s not there, and this lack of connection between people-related expenses and the balance sheet leads to poor and costly decisions.
When an organization invests in training people, it’s a cost. Many organizations are willing to make that investment because they know it can lead to improved products and processes, but it’s very difficult to see the actual financial value. Some companies try to capitalize training on the balance sheet, but in reality, that’s just an attempt to amortize and spread the cost over multiple years, not create a true asset.
When a company decides to chase “cheap” labor costs and move offshore, there is a reduction in expense on the P&L. But where is the loss of “our most important asset” reflected on the balance sheet? It’s not. Unlike when equipment or buildings are taken out of service, there is no similar disposal expense that moves from the balance sheet to the P&L when a large number of “our most important asset” are laid off. The bottom line of the P&L looks like it improved when in reality, a huge amount of value potential from creativity and experience has been removed from the company.
If a person leaves the company due to low pay, poor benefits, or ineffective management, where is the loss of value accounted for, besides being a relatively small cost to find a replacement? It’s not. There is no additional hit to the P&L bottom line driven by a reduction in asset value when there is high turnover.
If a company decides to invest in more than the minimal or required training for both new and existing employees, how does that investment directly convert into an improved asset value? It doesn’t. The company has to be enlightened enough to realize that there is long-term value, even if there isn’t an immediately recognizable impact on financial statements.
A team member with 20 years of experience, augmented (hopefully) by an investment in training, has more current value in terms of knowledge and creativity than a brand-new person hired at a new “low cost” location. A factory worker who can recognize issues and come up with new ideas for improvement, an engineer who can draw on a decade of experience to improve the design of a product, a leader who is an exceptional motivator of people and orchestrator of innovative strategies—there is tremendous real value in brains.
People, with their brains, creativity, and experience, are not considered assets on traditional financial balance sheets. GAAP and IFRS will probably not allow these types of people assets on audited financial statements anytime soon. Recognizing and understanding this flaw will help organizations make better decisions, even if the incentive of improved financial statements isn’t there.
