Why Finance Cares About HR

By David Creelman who can be contacted at:

dcreelman@creelmanresearch.com

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It’s a rare HR professional who reads the European Accounts Modernization Directive, US Securities and Exchange Commissions (SEC) circulars or opinions from the Institute of Chartered Accountants of Scotland.  However, as documented by the Organization for Economic Cooperation and Development (OECD), all over the world finance and accounting professionals are facing the question: Is accounting broken?

Who broke accounting?  Well, HR has to take a lot of the blame.  Much of the value of a company cannot be found on the balance sheet; it can’t be found in the cost of machines or the price of a building, the value a company creates comes from human capital. Accountants, finance professionals and even economists at the US Federal Reserve are concerned that various intangibles like human capital are invisible to investors.

Again, as the OECD has pointed out, accounting is not really broken, just incomplete.  Accounting is truly a magnificent (though tedious) invention and does an impressive job reporting on many aspects of an organization’s activities.  However, it simply doesn’t capture what’s going on in human capital.  What investors and the Board need is a supplemental report that goes beyond the financials and deals with the people management practices that make the company successful.

What does this mean to HR?  Well, the CFO and investor relations department are under increasing pressure to say something intelligent about human capital in the annual report.  Most HR professionals have not found out that this is going on.  There is pressure, but the dam hasn’t’ burst.  In my studies of the US Fortune 100 I see slightly improved reporting on HR from last year—but nothing so dramatic that HR would guess that a monumental change in their role is underway.   There are a few companies—GE and IBM are the two best—who seem to have a good handle on human capital, but they are exceptions.  What the VP HR has to worry about, is that one day the CFO will simply decide “I need to report on this, but I’ve never got anything useful from our own HR department and they seem only dimly aware of this issue.  I’m bringing in a consultant.”  HR risks finding themselves sitting off to the side as the CFO and CEO decide how to manage human capital.

I don’t expect HR professionals to read through tedious documents like German Accounting Standard 15 and they don’t need to.  While there are many different comments, advisories and guidelines issued by various accounting bodies it all boils down to one basic idea.  What the accounting bodies, financial regulators and investors want is for companies to provide some useful information to help them understand how human capital is impacting the firm.  For example, if the company is making a big investment in training as part of a strategic shift then please tell us because otherwise it just shows up as a big cost on the income statement and we’ll think the company is in trouble.  But accountants and finance professionals don’t know what to ask about human capital, so their ‘guidance’ is vague.  This is yet another reason why the VP HR really does not want the CFO to take the lead in reporting on human capital.  Basically, although not in so many words, the finance community is asking HR “Please tell us what we ought to know.”

HR should start providing a small report with information suitable for the Board and investors. The CEO may not feel ready to release this, but he or she needs to see something tangible that is aimed at that audience. If HR VPs spent their lives reviewing the literature of accounting intelligentsia then they would already be working on this.  However the push to disclose more about intangibles is largely happening below the radar, and it’s really time for a proactive HR department to step up to the plate.

What’s the win?  Well the obvious win is that it preempts the scenario of the CFO feeling forced to step in and do it themselves, because HR showed no initiative.  On a more positive note it will take HR to a whole new level in the organization, a level that reflects the dominant role human capital plays in creating wealth in the global economy.