For thousands of years, human civilization evolved through different economic eras. We transitioned from being hunter-gatherers to an agrarian society, where 90% of the population depends on farming for survival. The industrial revolution then reshaped the workforce, replacing physical labour with machines and making manpower seemingly replaceable.
Now, in the 21st century, we have rapidly entered the knowledge era, where intellectual capital has overtaken material assets in value. However, our financial and accounting systems still follow outdated industrial-era principles, ignoring human resources as a valuable asset on the balance sheet.
The Industrial-Era Mindset in Accounting
The economic theories and accounting principles that businesses still follow today were designed for the industrial age. Whether it’s GDP calculations or balance sheet assessments, financial reporting primarily focuses on physical and tangible assets. This perspective considers manpower as an expense, a liability to be minimized rather than an asset to be nurtured. Investments in workforce skill enhancement, such as training programs, workshops, and development initiatives, are classified as revenue expenditures rather than capital investments. In contrast, upgrading machinery is considered a capital expenditure and recorded as an asset. This practice and approach is still fairly common, even though a highly skilled workforce contributes more significantly to a company’s success than outdated machinery.
The Case for Recognizing Human Capital as an Asset
Many argue that human capital is intangible and difficult to quantify in hard numbers. However, the impact of a well-trained, highly skilled workforce is very clear and evident. A company with superior human capital is better equipped to navigate crises, innovate, and sustain long-term growth compared to a competitor with an unskilled workforce. Yet, financial analysts and banks do not factor this human factor into their assessments. The current system fails to acknowledge that two companies with identical tangible assets on their balance sheets may have drastically different capacities and scope for success, based on the quality of their human resources.
The argument that goodwill or equity valuation reflects an organization’s true human resource strength is insufficient. Unless human capital is explicitly quantified and given the due recognition on financial statements, HR policies will continue to be seen with doubt and will likely be cut first during an economic downturn, with cuts in training budgets and workforce development initiatives.
