Measuring how 'human capital’ appreciates in value over time

Suppose you were a board member and your CEO announced at a board meeting that a major plant, one in which the company had invested hundreds of millions of dollars, was being disposed, resulting in a major charge to the company. How would you feel about his judgment? On the other hand, if these were human assets being disposed through layoffs, how would you feel? If you’re like most, ther...


Suppose you were a board member and your CEO announced at a board meeting that a major plant, one in which the company had invested hundreds of millions of dollars, was being disposed, resulting in a major charge to the company. How would you feel about his judgment?

On the other hand, if these were human assets being disposed through layoffs, how would you feel?

If you’re like most, there seems to be a tendency to place a greater sense of loss on the disposal of fixed assets than there does on the 'disposal’ of people, perhaps because of the belief that a greater cost is eliminated with the people. Whether this is appropriate or not can vary with the business circumstance.

The value of human capital should be more fully accounted for when making these decisions. And, the accounting practices currently employed by most companies can have undue influence in driving the strategic decisions of many organizations. Fixed assets are treated as assets that depreciate over time. But, employees are treated as expenses, yet they appreciate over time with additional training and experience. The accounting of people should be such that their value as a corporate asset that appreciates over time is properly treated.

Many studies indicate that cost cutting through layoffs has a high risk and a low probability of success. David Stamps also observed that downsizing, in many cases, is driven by a short-sighted, bean-counting mentality rather than a strategic, long-term vision required to reshape a company into a smaller but healthier organization. Wall Street often rewards large layoffs with a jump in stock price; cost cutting must be good, since it will improve the bottom line.

However, the evidence suggests that cost cutting is a poor bet, no matter how it is presented (e.g., downsizing, right sizing, restructuring and so on). This is not to say that cost cutting never applies. Not all the companies studied suffered as a result of their cost cutting. Again, it may apply, for example, if you’re on the verge of collapse and have no choice to survive; if you’re a bloated bureaucracy and must do so to assure your longer-term success; or if you’re faced with intransigence in unions or employees and need to get people’s attention; in specifically targeted situations of obvious waste; or, finally, in a major market downturn or situation of global oversupply that severely depresses prices.

Parallels in cost analysis

There are direct parallels between the process of acquiring an employee (a human capital asset) and that of acquiring a fixed capital asset. In acquiring a fixed asset, the company first identifies a need and then writes a specification. Then it issues a request for quotation and invites interested suppliers to bid. After evaluating the bids, the company selects the supplier. The equipment is delivered and installed. The company trains its workforce on how to operate, troubleshoot and maintain the equipment. The equipment is started and production begins.

If all goes smoothly, after a period of time the asset will be fully functional, and the company will have met its need by applying capital in an effective manner (e.g., expanding capacity, solving a production problem, addressing an environmental requirement and so on).

Other considerations in the process include:

  • The capital expenditure being in line with the company’s strategic plans for new products, markets and so on

  • The expected rate of return on the investment

  • The cash flow effects

  • The cost of capital

  • Any foregone opportunity for using the capital in some other manner

  • The anticipated life of the equipment

  • The tax consequences of the capital purchase.

    • It would be rare for a company to purchase fixed capital equipment without having a good estimate of its costs and benefits.

      Measuring human assets

      In acquiring human capital, most companies follow a similar process as that used for acquiring fixed capital. Most are able to estimate the cost in the process of acquiring those assets, even if they do not put the same precision into the actions as they would for acquiring a fixed asset. The balance of the steps may be more difficult, but follow analogous steps for acquiring fixed assets.

      For example, the task of preparing the site for delivery and set up of the equipment is analogous to preparing the 'site’ for a new employee’s arrival.

      The employee must have an office, a desk and chair, a telephone, supplies and often a personal computer or other tools. If an employee arrives and has nowhere to work, then training and productivity are delayed. If there is an office, but no computer or telephone, productivity is delayed. In any event, the company wants the asset to be as productive as possible as soon as possible.

      Further, timely and appropriate training activities must be scheduled in order to get the employee 'installed and started up.’ These activities may take days, months or even years, depending on the position and the company. During this time, the employee is typically minimally productive, while collecting full salary and benefits.

      In the same way that proper installation of capital equipment and effective training of the workforce on its use are essential to the startup phase and to the planned return on a company’s investment, identifying, selecting, recruiting and training the best qualified individual are also vital to making his startup phase effective, so the company may realize a return on its investment in that asset.

      A company’s balance sheet includes its assets and its liabilities; those assets typically are current assets, property, plant and equipment and other assets. Unfortunately, nowhere does the balance sheet state the value of the company’s human capital assets. It should, or at the very least it should allow, an estimation and notation of that asset value.

      Most companies, while acknowledging the contributions of its employees, do not think of the acquisition (or disposal) of human capital assets in the same way or with the same thoughtful planning or strategic thinking as they do fixed capital assets.

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      Excerpted from the new book, “Selecting the Right Manufacturing Improvement Tools %%MDASSML%% What Tool? When?” by Ron Moore, published by Elsevier Books, Butterworth-Heinemann Imprint. Ron Moore is the managing partner of The RM Group, Inc. He can be reached at (865) 675-7647 or by email at .