The Need for a New Balance Sheet for Business

As far as I have observed, people start businesses for four possible reasons: either to generate income, to build wealth, to enhance their ego, or to provide some service to their community (very narrowly or globally or anywhere in between). Each goal does not exclude any of the others.

For those who are in business to generate income, the most important measurement that can be used to judge success is the P&L because, quite simply, it reports the profit and profit translates into income to the business owner(s). For those who are in business for the sake of ego, I guess the most important measurement device is the way people react when they hear their name or see them. For those who want to use their business to improve the quality of some community, large or small, success can be measured by personal observations or by some other indicator such as awards bestowed by organizations that value the good deeds.

But, for the most part, businesses are started to build wealth for the owners (sometimes including outside investors), and for them the most important measurement device is the balance sheet because it quantifies the value of the business’ assets and liabilities, and then the net worth (wealth) simply by subtracting the liabilities from the assets. The balance sheet as we know it has worked well for a long time, but it is has become largely out of date and is becoming increasingly irrelevant.

The balance sheet as we know it was constructed for industrial-age businesses because the most important assets it measures are property, plant and equipment, which are all fixed assets and depreciate over time. But consider the modern business and envision the businesses that characterize what Toffler called “The Third Wave” and “The Creative Economy” as identified by Richard Florida (Hirst Professor at George Mason University and author of “Rise of the Creative Class” and “Flight of the Creative Class”). These businesses do not have property, plant and equipment as their most important assets, but human beings (which actually appreciate as they build expertise and skills). What would Microsoft (or its shareholders for that matter) consider its most important assets: the value of its campus in Seattle, as substantial and awe-inspiring as it is) or the value of its employees who develop its software, conceive of its marketing plans, sell its products and services, populate its help desks, and manage its affairs? I know at Qorvis, as a public relations firm, our assets are virtually entirely comprised of the people who are, in the final analysis, synonymous with the company itself, and we manage the business accordingly.

But where do those assets show up in the balance sheet of either Microsoft or Qorvis or any other company? Human assets don’t appear on the balance sheet at all. Consider then this question: if the balance sheet was devised to indicate the value/worth of the business, and their isn’t a single line item to reflect the most important asset of many businesses (people), then isn’t it accurate to conclude that the balance sheet has become largely (if not totally) irrelevant for contemporary businesses?

There is a real consequence to this shortcoming. One of the things I’ve discovered over the course of my career is that measurement devices usually drive how things are measured. So, for example, if a company measures the productivity of its employees by the device of a time sheet, then the management of the company focuses on how much time people spend on an assignment and how much that costs based on the time spent. Consistent with that, they remunerate people on the basis of time and they charge their customers for their products and services on the basis of time. Compare that to a company that measures success by virtue of the value they add to their customers’ success as opposed to the amount of time spent to deliver their product or service: the people of that business do not keep time sheets and they do not get remunerated on the basis of time, and the customers pay for the value they expect to realize from the product or service. In this example, two different measuring devices (an analysis of time versus an analysis of value added) yield two entirely different approaches to how the business is managed in virtually every regard.

Now, let’s look back at the balance sheet as it exists today, from the perspective of how good it is as a device to measure value. Those who use the balance sheet to determine the worth of the company will be focused on property, plant and equipment and how much those fixed assets have grown and what they are worth. Where does that leave the Management of a company that appreciates that its human assets are more important than its fixed assets? Where does that lead the investors who understand the importance of human assets versus fixed assets? It leaves both Management and investors with an irrelevant measurement device: the balance sheet as it currently exists.

Why should the balance sheet designed to reflect the value of an industrial age business (or economy) also be the same measurement device used to determine the value of a human-asset-based business? In my mind, the answer is clear: the current balance sheet is outdated for “Third Wave” or “Creative Economy” businesses and should be either ignored or, better yet, replaced. The problem with that is: changes to the way businesses use balance sheets is in the hand of accountants (through their professional association, the AICPA, which establishes GAAP – “Generally Accepted Accounting Principles”) or the US Government (through the SEC, which establishes reporting standards for publicly owned companies). It is not likely that either of those two groups will initiate an effort for change.

And, thus, we will continue to use (or ignore) an outdated and increasingly irrelevant measurement device to determine an organization’s value until some individual or organization decides it is time (or, more appropriately, past time) to figure out some way to measure value with a more meaningful system.
- Doug

Thoughts from the CEA Show 2006

Having attended the CEA Show in Las Vegas for the past few days, I have become increasing convinced that a theory of mine is about to come true: the Internet will die.

I believe things die when they become ubiquitous because when something is everywhere it is no longer seen. Consider, as a prime example, the transistor. I remember as a kid in the 1950s when consumers became aware of transistors because of their use in portable radios. Until that time, any portable radio was very bulky and heavy and didn’t have especially good reception. Transistors changed that. For a while, it seemed, everyone walked around with transistor radios held against their ears. The portable radio was no longer considered a “radio,” but was generally called a “transistor” as in “I’m going to listen to my transistor.”

As the boom in the sale of transistor radios continued, the news about the potential of transistors to change the world increased as well. It became generally accepted that transistors would change the world. They would be everywhere. The predictions were correct: transistors did change the world and they are everywhere. The point is, that they are so “everywhere” that they are invisible. People do not think of transistors at all. The Headlines about how transistors would change the world no longer exist. Nobody ever says “I’m going to turn on my transistor” anymore. Ultimate success leads to ubiquity; ubiquity leads to invisibility; invisibility, for all practical purposes, leads to death.

The single most dominant trend that I took away from the CES show was the crushing evolution of the Internet and the final stages of the emergence of the networked world. The television and the Internet are merging. Telecommunications and the Internet are merging. Entertainment and the Internet are merging. The Internet is becoming ubiquitous. It is in the early stages of becoming invisible. We are not very far from the phrase “I’m going to log on to the Internet now” becoming as rarely used as the phrase “I’m going to turn on my transistor.” We will simply live in a networked world just as we live in a world where the transistor is everywhere. The Internet will truly change the world, just as the transistor did indeed change the world. And, just as in the case of the transistor, we will all take this change for granted, and not give much thought to it, just accepting it as “the way things are.” That is, until the next benchmark event occurs and then maybe someone will say something like “I remember when I was a kid people were also saying that the Internet would change the world also ….”