Human Capital: The Unseen Asset in Financial Analysis

Aug 3 / Geoff Robinson




In today's knowledge-based economy, human capital—employee knowledge, skills, and capabilities—has become a critical driver of organizational performance and success. Yet, when we look at a company's balance sheet, one of the most significant assets is often missing: human capital. This blog post will explore why this vital resource is not recognized on the balance sheet and how its absence can potentially mislead investment analysis and recommendations.

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Human Capital: An Invisible Asset
Human capital refers to the value employees bring to a company through their knowledge, skills, and abilities. It's the collective sum of attributes, experience, and potential of a company's workforce1. Despite its importance, it is not recognized as an asset in traditional accounting methods.

Why is this the case?
Human capital doesn't meet the conventional criteria to be considered an asset under accounting standards. Assets are typically defined as resources controlled by an entity due to past transactions or events and from which future economic benefits are expected to flow to the entity2. Because employees are neither owned nor controlled by a company in the same way as physical assets, human capital cannot be classified as an asset under this definition.

The Implications for Investment Analysis
The omission of human capital from balance sheets can have significant implications for investment analysis. Financial analysis and valuation often rely heavily on a company's financial statements, and this analysis may be incomplete or misleading if a significant part of a company's value is missing.

For example, two companies in the same industry may have similar financial profiles—similar revenues, profit margins, and assets on the balance sheet. However, if one company has significantly stronger human capital—more skilled employees, better leadership, and more innovative capabilities—this company might be the better investment. But this difference wouldn't be visible in the financial statements3.

Moreover, human capital-intensive companies might appear less profitable or more leveraged simply because a significant portion of their value—employee skills and capabilities—isn't reflected on the balance sheet4.

The Future of Accounting for Human Capital

Given the growing recognition of the importance of human capital, there are increasing calls for more detailed disclosures about a company's human capital resources. The U.S. Securities and Exchange Commission (SEC) recently introduced rules requiring publicly traded companies to disclose human capital measures or objectives that the company focuses on in managing the business5.

But this is not enough. There is a long way to go before analysts can properly analyze arguably a company's most important asset. Investment analysis will always fall short unless this insight can be improved.

Footnotes
Becker, G. S. (1994). Human capital revisited. In Human Capital: A Theoretical and Empirical Analysis with Special Reference to Education (3rd Edition) (pp. 15-28). The University of Chicago Press. ↩
International Accounting Standards Board. (2021). Conceptual Framework for Financial Reporting. https://www.ifrs.org/-/media/project/conceptual-framework/conceptual-framework-for-financial-reporting.pdf ↩
Barth, M. E., & Intintoli, V. (2018). Firm-specific human capital and corporate financial policies. Journal of Corporate Finance, 48, 115-132. ↩
Rajgopal, S., Venkatachalam, M., & Jiambalvo, J. (2002). Is institutional ownership associated with earnings management and the extent to which stock prices reflect future earnings? Contemporary Accounting Research, 19(2), 283-318. ↩
U.S. Securities and Exchange Commission. (2020, August 26). Modernization of Regulation S-K Items 101, 103, and 105. Federal Register. https://www.federalregister.gov/documents/2020/08/26/2020-17506/modern ↩