Capital is the lifeblood of a corporation. It allows a business to maintain liquidity while growing operations. Generally, capital is used to refer to physical assets in business. It is also used to refer to the means in which companies obtain physical assets.
What Is Physical Capital?
Physical capital consists of manmade goods that assist in the production process.
Cash, real estate, equipment and inventory are examples of physical capital. Physical capital values are listed in order of solvency on the balance sheet. The balance sheet provides an overview of the value of all physical and some non-physical assets. It also provides an overview of the capital raised to pay for those assets, which includes both physical and human capital.
Physical capital is recorded on the balance sheet as an asset at historical cost, not market value. As a result, the book value of assets is generally higher than market value. Accountants refer to physical capital as a tangible asset.
What Is Human Capital?
Intangible assets are non-physical capital. A balance sheet only lists intangible assets when they have identifiable values. Intangible assets can’t be touched, but they are often represented by a legal document or paper.
Human capital is represented by more than the company brand. Harvard University is not Harvard University because of its crimson logo. The value of Harvard University is in its human capital. Human capital includes the knowledge base of the employees and is often measured by the quality of the product. It also refers to the network of the employee base and the general level of influence they have on the industry.
Examples of intangible assets include intellectual property such as brands, patents, customer lists, licensing agreements and goodwill. Goodwill is created when one company acquires or purchases another and the purchase price is more than the physical assets being purchased. The difference is recorded as goodwill, and one of the largest components of goodwill is human capital. In fact, goodwill is one of the only places where an analyst can find a value for human capital on the balance sheet.
Human Capital vs. Physical Capital
Unlike physical capital, which is easy to find on the balance sheet (and in the notes to the balance sheet), the value of human capital is often assumed. In addition to goodwill, analysts can value the impact of human capital on operations with efficiency ratios, such as return on assets (ROA) and return on equity (ROE).
Investors can also determine the value of human capital in the markup on products sold or the industry premium on salary. A company is willing to pay more for an experienced programmer who can produce a higher-margin product. The value of the programmer’s experience is captured in the amount the company is willing to pay over and above the market price.
The Bottom Line
While human capital can be difficult to measure, the impact of investments in human capital can be measured and analyzed with the same ratios used to measure and analyze the investment performance of physical assets. Investments in physical and human capital both lead to fundamental improvements in the business model and better overall decision-making.