Make sure human capital counts.

Listed European firms have an average of EUR542m (#345m) in ‘knowledge capital’, according to a research report by Butler Group associate Paul Paul Strassman.

His firm has developed a knowledge capital metric to measure objectively the capacity of a company to generate profits by other means than through financial capital.

Strassmann says: ‘If society is to evolve successfully from an industrial model to an information-based economy, knowledge assets and the methods of protecting them will become increasingly important.

‘However, financial executives have shown a reluctance to put value to something they perceive to be intangible.’ He is right, and investors are unlikely to see companies following his lead and putting ‘knowledge capital’ in their annual reports and accounts.

Despite this hole, the profound implications of human capital for creating competitive advantage are increasingly being acknowledged.

For instance, the ICAEW says people have become the key drivers of profitability.

But it is looking to the government to take the lead on human capital working with all sectors of the economy in order to develop best practice, ensure transparency of process, as well as crucially formalising valuation techniques.

Not everyone is waiting for government direction. The company that has gone furthest is Swedish insurance giant Skandia, led by its director of intellectual capital Leif Edvinsson. He has pioneered methods to provide a more balanced picture of operations than conventional accounting statements.

Skandia’s annual report says the investment made in renewing and developing human, customer and process capital drives its financial success. The Skandia Intellectual Capital Index aggregates over 100 variables and measures not only conventional metrics, market share and contracts won, but more unusual measures, such as totals of women in management and laptops per employee.

There is no clear view how human capital in particular would be valued and disclosed in annual reports and accounts. Some measures could be disclosed in the operating and financial review. Apart from using overworked cliches about how marvellous their employees are, companies could relate more objective measures: pharmaceutical companies could disclose the number of employees with PhDs. But there could be other simple changes that reflect the increased importance placed on the workforce without going as far as Skandia.

At the moment financial reporting differentiates between human capital and tangible assets and this clearly influences investors’ and managers’ views. The fact that training expenditure is not capitalised as an asset and carried in the balance sheet means that such expenditure (or should that be investment?) is not subject to the same scrutiny as other ‘assets’.

While more traditional accountants might shudder at such a move, others would see it as just a start. ?:

Related reading