What your balance sheet omits [human capital]

29 January 2021

reading time:  minutes

Your balance sheet provides a simplified view of assets you own which you can sell relatively easily, and which you can put a relatively stable value on. It omits some other valuable assets.

Consider, however, that your balance sheet might omit one or more important assets. You might, for instance, own an asset which is able to generate a regular income over the course of, say, the next 5, 10, or 40 years. An asset that could reliably generate income would be extremely valuable.

The most notable omission in a traditional balance sheet is human capital, or your personal ability to generate an income. For most households, the accumulation of wealth, in the “balance sheet” sense of the term, represents a process of using human capital to generate income, which is translated, in part, into assets that show up on a balance sheet via savings and investment.

Thinking about human capital in this abstract, financial sense can be illuminating from several perspectives:

  • Sometimes, spending money on yourself – for example, on education – can be a very effective investment. This expenditure may not show up on a balance sheet, but if it increases your potential earning power over the rest of your career, it can generate a significant return on investment, resulting in you having more investment assets over the long run.
  • Similarly, taking career risks can be extremely valuable from a narrow, financial perspective – let alone from a broader, personal, quality-of-life perspective. A career risk can involve taking time off (ie, a sabbatical), to get some perspective on how things are going, providing an opportunity to consider other opportunities to use the capabilities, skills, and knowledge that you’ve acquired over time. Alternatively, some people can take career risks by making a lateral move – into a lower-paying role that might have more earning potential (or be more rewarding in general) on the basis that this choice will involve taking one step back in order to take two steps forward. Of course, there are risks, which is why I refer to this as a career risk.
  • It provides insight into the value of insuring your ability to generate an income. If you had an asset that was likely to generate, say, $1 million or more over the rest of your working life, and it wasn’t able to generate that income for one reason or another (such as illness), it would be prudent to insure that asset. This makes intuitive sense for people in relation to tangible assets like cars and houses, but it can be a bit harder to intuit when it comes to your income.

It’s important to give serious thought to how you’ll invest the assets on your balance sheet. It’s just as important – and in many cases, much more important – to think about how you’re going to develop and utilise your human capital.


Tags

balance sheet, human capital, intangible, intangible assets, shadow assets


About the author 

Sonnie Bailey

When he's not writing erotic, supernatural, mystery novellas, Sonnie provides financial planning services via his business, Fairhaven Wealth (www.fairhavenwealth.co.nz). Fairhaven Wealth provides independent, advice-only, fixed-fee financial planning services. Sonnie is also a “recovering lawyer”: he has specialised in financial services, trusts, and estate planning.

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