Why are employees not assets, in the balance sheet sense?

Why are employees not assets, in the balance sheet sense?You ever hear a CEO say, “Our employees are our greatest asset”?

It’s not technically true. In a colloquial sense, yes, employees help a company deliver a lot of value to customers. But in the formal, literal sense…no. Employees aren’t assets. Employees don’t appear on a company’s balance sheet.

It’s all about ownership

Why are employees not assets? The short answer is because the company doesn’t own the employees.

Here’s the definition of asset from Investopedia:

An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets are reported on a company’s balance sheet, and they are bought or created to increase the value of a firm or benefit the firm’s operations. An asset can be thought of as something that in the future can generate cash flow, reduce expenses, improve sales, regardless of whether it’s a company’s manufacturing equipment or a patent on a particular technology.

As an example, let’s look at Apple’s balance sheet, from its most recent 10-Q report:

Apple's balance sheet

What do you see? Cash. Investments. Inventories. Property, plant, and equipment. But not people.

The company owns the assets on its balance sheet. In some cases, the company owns a controlling interest, and not the whole asset. Regardless, the concept of ownership is very important. And we have rightly built a system where companies cannot own people.

Then why do leaders call employees assets?

Because if you ignore the ownership criterion, employees behave exactly like assets. Employees have, and produce, economic value. Good employees make the company more valuable. Good employees compound the gains from the balance sheet assets.

Good employees have skills, which you can think of as intangible assets. As we build a more knowledge-focused economy, our bodies matter less. Our minds matter more.

Employees are like assets in another way. All else being equal, the employees that bring the most value cost the most. Companies pay more money for more productive equipment. A machine that yields 2 widgets per hour is more valuable than one that yields 1 widget per hour. Likewise, a more productive employee is more valuable than a less productive employee.

Employee productivity comes in a lot of forms. The valuable employee may produce a large volume of output. The valuable employee may have a scarce skill. The valuable employee may bring the team together, multiplying the productivity the team would otherwise have.

In the day to day sense, employees are very much assets. That’s why senior leaders talk about them that way. It’s not a ruse.

How can we account for the economic value of employees?

We know that employees don’t appear on the balance sheet. Unlike a piece of equipment, they don’t have an assigned economic value. How do we know what value employees actually bring?

To get the answer, we look at the income statement. The income statement tells us about the company’s revenue, costs, and profit. Say two companies have the exact same asset base. Say that one company has more productive employees than the other. We would expect the first company to generate

  • more revenue at the same cost,
  • the same revenue at lower cost, or
  • more revenue at lower cost.

That’s the power of top notch employees. And you wouldn’t know it from looking at the balance sheet. Their balance sheets are identical.

Let’s take two fictitious pharmaceutical companies: PharmaCo and DrugCo. They have identical assets. They have the same types of buildings in the same geographic locations. They have the same lab equipment. They spend the same amount on their research and development (R&D) programs.

Here’s the difference. PharmaCo has better research scientists. Their scientists discover more marketable drugs, more frequently than DrugCo’s scientists. With identical asset bases, PharmaCo will generate more revenue at the same cost, assuming they’re paying the same amount for their scientists.

Even if PharmaCo has to pay a premium for its scientists, the premium will generate incredible returns. The stakes in the pharmaceutical game are so high that even small edges can yield massive benefits.

What we need to do, then, is compare what we see on the income statement with what see on the balance sheet. That’s how you get to a metric like return on assets, which is net income (i.e. profit) divided by total assets. Net income comes from the income statement. Total assets come from the balance sheet.

PharmaCo and DrugCo have the same total asset value. They have different net incomes. We would see that PharmaCo has the higher return on assets, which is an important indicator of corporate financial performance.

In short, employees are definitely assets

Why are employees not assets on a balance sheet? Because the company doesn’t own them.

But the employees are definitely assets. They generate considerable economic value. They represent a huge share of the cost for any company.

Keep that in mind, when you’re studying the financial performance of a particular company. The balance sheet doesn’t give you a complete picture. Yes, larger companies (by valuation) tend to have larger asset bases. But it matters what employees are controlling those assets. Employees make decisions about how and when assets are used. While two assets may have the same book value, they may generate wildly different economic values, depending on the employees controlling them.

I’ll close with one of my favorite quotes from Warren Buffett. He explains how important people are, when it comes to generating value from assets:

A dollar of then-value in the hands of Sears Roebuck’s or Montgomery Ward’s CEOs in the late 1960s had a far different destiny than did a dollar entrusted to Sam Walton.

 

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