Owing to a shift from production to service-based knowledge economy, the old mantra of ‘cash is king’ has been replaced with ‘talent is king and cash is queen’.
Business leaders need to re-examine how they can unleash and leverage human potential in an increasingly volatile and constantly changing environment.
Generally Accepted Accounting Principles (GAAP), embraced by manufacturing and distribution companies, focused on four things: cash, inventory, buildings and equipment.
In an industrial economy, the number one expense is inventory. By the end of the 20th century, this economic model was being replaced with a ‘knowledge’ economy based model, more on information and services. The number one expense in the new knowledge economy is people. This requires a new set of standard accounting reports and principles to plan for, track and measure a company’s success and value.
A new set of financial standards in the form of IFRS has replaced GAAP, but still it uses currency as the common denominator for investment that sees value primarily in the context of ‘things’ (inventory, land, building, equipment, stock, cash, etc.), rather than introducing a new focus on human capital talent as part of the overall value of a business. Therefore, further change is needed to recognise the growing importance of talent as it relates to the health of evolving corporations.
When using GAAP or IFRS, both standards still place the primary emphasis on the value of company’s financial performance in relationship to earnings and stock prices, which perpetuates the focus on short-term gains. But stock prices are not a true long-term gauge of the value of a company. When evaluating the short-term value of a company, it is easier to ask how much cash and profit the company has generated, and relate those facts to stock value. The problem is that business managers can manipulate cash, profits, and stock prices by simply buying back their shares in the open market. Due to this phenomenon, no actual value is generated for investors or stockholders, but all the financial indicators show improvement.
Another way to manipulate the short-term cash, profits, or stock prices of a firm is to layoff talents and assure that next few quarters magically improve. In both cases, the short term ‘improvement’ wears off in a few quarters when the company does not have the talent to execute its strategies or the cash to invest in its expansions and workforce.
The current financial reports place too much emphasis on profitability and stock price (earning per share), which only reinforces the ongoing short-term approach. In a global knowledge-based economy, a shift is drastically needed to put emphasis on understanding talent demographics.
The combination of right skills is the actual recipe for what a company needs to grow over the long run. A strategic approach puts the value and importance on talent rather than land, building, equipment and inventory. The need for long-term focus was pronounced louder in the years following the financial crisis. Some changes have occurred in the global landscape which help shift that focus, such as the requirement to disclose CEO and board member compensation, but that is not enough.
Executives often say ‘people’ are their greatest assets. Human Capital Metrics reporting provides the mechanism for demonstrating those assets and reinforcing the truth of that exact sentiment. Since human capital has a material impact on organisational performance, it is of interest to investors; therefore establishing a respected and durable measurements and disclosure framework of human capital is crucial for presenting a full picture of the performance and value of an organisation.
While many aspects of human capital are hard to measure, there are some important aspects of it that are readily measured. Human capital metrics reporting structure offers a new way to evaluate the true value of a company by using information that encompasses the unrecorded/excluded workforce portions of a company.