CORPORATE LEADERSHIP

Annual accounting of human capital - a necessary step in our knowledge society?

Sabine Walter, Head of netzwerk managementberatung | coaching, in conversation with Eda Wolff and Svenja Stöveken, both management consultants at Horváth, an international management consultancy for transformation, performance management and digitalisation

Human capital - the most important resource of our knowledge society

Sabine: All companies have recognized that the people in their organization, with their expertise, represent the most important resource. Isn't it about time that the cost item "personnel" in the P&L statement is countered by an asset in the balance sheet? Or to put the question even more precisely: Why do investments in machinery and equipment only have an effect on the P&L in the amount of their depreciation? However, the full amount of training costs is included in the costs and therefore also reduces the full amount of net income for the year.

Svenja: These are absolutely legitimate thoughts. In a manufacturing society, determining the assets of a company is quite easy, in which - to put it simply - the machinery, equipment and real estate are considered.

In the meantime, however, we are in a knowledgebased society and are noticing more and more that the main value of a company consists of its human capital, i.e. the expertise and ideas of its employees and managers.

For this reason, the issue of visualising this value, including in the form of a balance sheet, has been discussed repeatedly for several years. A solution has not yet been found. In your opinion, is the accounting of human capital a necessary step in our knowledge society?

Annual accounting of human capital has advantages and disadvantages

Svenja: Let's look at the pros and cons. For example, if we were to report training investments on the balance sheet as an asset, it might encourage companies to invest more in training. Perhaps training would also not be the first to fall victim to the red pencil as companies look for cost savings. But training does not fully reflect a company's human capital. The sheer amount invested, for example, says nothing about how effective training is in terms of a company's competitiveness. At the same time, it could encourage companies to artificially inflate the balance sheet value via further training investments.

So we come back to the question: How could human capital be clearly measured?

We will not be able to answer this question finally here and now.

I would therefore like to take a closer look at the question of benefits. "What is the benefit to employees if they appear on the balance sheet as an asset? Isn't it much more important to honestly value, promote and develop employees and give them room to manoeuvre?"

Eda: Before I answer this question, I would like to say something about the balance sheet. What has been transparent so far and can be found in annual reports are the investments in research and development. They clearly show how much a company invests in its future and the further development of products and technologies.

But now back to the benefits question: "What would be employees' all in all benefit if their human capital is reported on the balance sheet?"

Of course it sends a strong message if companies can provide concrete figures to prove how much they invest in employee development. But they can already do that today - regardless of whether these investments are on the balance sheet or the income statement. Unfortunately, however, we have also observed that these investments do not necessarily lead to greater employee satisfaction. Core elements for high employee satisfaction are and remain a trusting and appreciative leadership, freedom to shape and make decisions, and the opportunities to further develop oneself.

Svenja: I totally agree with that. I would like to bring in another thought. In some companies, the success of the company and also the equity story depend on a few key players. Assuming we were to account for this know-how, what happens to the balance sheet value of a company when these people leave? And would the mathematical reduction of the balance sheet value correspond to the effective reduction?

Sabine: That's an interesting thought. But perhaps accounting that expertise would make companies more likely to take a much more strategic approach to their workforce and succession planning than they have so far.

Strategic human resources planning and conscious leadership as a central element in enhancing knowledge transfer between generations

Eda: Strategic human resources planning is my keyword. We see that more and more companies are thinking about it and are developing and professionalizing this process of strategic HR planning and the associated succession planning with our help. It even happens occasionally that the personnel strategy becomes an integrative part of the corporate strategy.

The first step in making this happen is to create transparency. Transparency that many companies do not yet have. Who is joining? Who is leaving? What competencies does the company have? How will certain roles and areas of responsibility develop? What competencies will the company need in the future to completely fill these roles? Which roles need to be replaced and in what form?

We answer these questions together with our client companies. If it is clear which competencies can be lost due to the departure of employees, we develop approaches to avoid or reduce this. And that brings us to the topic of "knowledge management" or "knowledge transfer".

How does a company manage to reduce the amount of individual expertise? How do people succeed in sharing their knowledge and expertise and passing it on to others? And in answering these questions, we quickly come across two central aspects: What are people valued for in an organization? And how well does intergenerational cooperation work? These questions must become key concerns for managers.

Professional off-boarding: a process to keep human capital in the company

In addition, the off-boarding process can of course be professionalized. "What, dear experienced employees who will soon be leaving the company, would you necessarily like to pass on to the others? What are your lessons learned?" Companies can plan and actively facilitate such an exchange so that key experiences, expertise and insights remain within the company.

Svenja: This is something I would like to pick up on. In my opinion, it is not only the transfer of knowledge that needs to be managed today. Rather, the question of intergenerational exchange should also be given even greater focus during the active time of older employees and not just shortly before they retire:

How well do teams succeed in appreciating the different experiences and perspectives of the various generations and perceiving them as enrichment? How can managers actively encourage this exchange so that the valuable impulses of the experienced generation bear fruit together with the "young wild ones"?"

Ecosystems - a key entrepreneurial element in the knowledge society

Sabine: These are interesting questions and definitely important for the long-term competitiveness of companies. At this point, I would like to come back to the aspect of strategic HR planning. To what extent is the question of make or buy also considered in this planning? In other words, what competencies do companies build up themselves and what competencies do they cover through strategic collaborations?

Svenja: You mention the ecosystem of a company. This is a key element of sustainable business management. More than ever, companies are required to build and maintain trustful partnerships in order to be able to react quickly to changing market, technology and know-how requirements. As a rule, several partners are part of such ecosystems and together create something that generates a real USP.

And to return at this point to the initial topic, that of accounting, the question arises: "How would a company account for the know-how of people who are not on its payroll, but who, together with a team from its own company and other partners, create added value, fill its order books and contribute to increasing the company's value?"

Svenja: And another aspect that we haven't even looked at yet, and that would also go beyond the scope today, is the aspect of AI and the question: "What happens to human capital when AI takes up more and more space and the interaction between human expertise carriers and AI becomes ever closer and thus more difficult to differentiate?"

Appreciative Leadership and talent management more important than dry balance sheet metrics.

In summary, I would say that accounting of human capital is and remains complex, and I would venture the thesis that it would not necessarily indicate the value that employees and managers bring to a company.

I would like to underline this thesis with an example from one of my client companies. It has succeeded in taking a more holistic approach to talent management, successfully linking co-design and innovation, and creating concrete added value.

What did they do? They asked the question "What are high-potential growth ideas for our company?" and launched idea contests for this purpose. The ideas received were evaluated and now comes the crucial point:

The best ideas were not only awarded prizes, but the employees who contributed the top 2 ideas were freed up for a defined period of time, given a budget and a team, and allowed to develop their two ideas to market maturity. When the market was ready, these areas were spun off and the idea providers were given shares in these start-ups and allowed to continue running them.

When companies take this approach, they achieve enormous commitment across the entire workforce and reach a radiance beyond the company's boundaries. This has a much greater impact than a dry number on the balance sheet.

Eda: Definitely, because - irrespective of the question of accounting - it is the top management of a company that decides how employees are valued, supported and developed. This means that the C-level must understand that their performance and that of the company is only good if the employees have the right competencies and put their heads and hearts into their work. Creating this understanding and ensuring that employer branding is not an empty facade, but that corporate culture and leadership create the framework for all members of the organization to be willing and able to give their best, is also part of our consulting service.

Of course, it helps if I can also have this discussion at C-level based on KPIs. But I still have my doubts as to whether this requires human capital accounting or whether existing, clearly measurable KPIs such as employee satisfaction, sickness and staff turnover rates are not sufficient for this.

Svenja: That's how I see it. When employees are satisfied, they are much more loyal, creative and productive. And that can also be proven by figures.

In companies that are highly engaged in sustainability, employee productivity is 16% higher, loyalty is 38% higher, and fluctuation is 50% lower than in companies that are less sustainable. (Source: Horváth Research)

And to add one more figure. We at Horváth conducted a CxO Priorities Study 2023 among 430 CXOs worldwide. The question of this study was: "What are the top topics on the CxOs' agenda?". One result of this survey is that "People" is the number 1 topic on the agenda. Shortage of skilled workers, succession planning, war for talents... C-level executives are absolutely aware that the long-term competitiveness of the company, more than ever, depends on the company's employees and managers. They define a company. They contribute ideas. They develop business models. Of course, this is not a new insight. But the fact that this topic has overtaken all other priority topics such as cost management, energy conversion and cyber security in terms of importance and urgency significantly underlines the importance of human capital as a business success factor.

Sabine: Ladies, thank you for this exciting exchange. What I take away from our discussion is that a lot has happened in terms of valuing and developing the most valuable resource of all - people. The key to this is and remains leadership - regardless of how the question of accounting for human capital develops.