There are three critical pieces of information for every business: the P&L statement, the cash flow statement, and the balance sheet. Together, they tell how profitable (or not) the enterprise is, how it is positioned to pay its obligations, and the net value of the business. The balance sheet as we know it has worked well for a long time, but it is has become largely out of date and is becoming increasingly irrelevant and in some ways counter-productive.

The most important assets that impact the current balance sheet are hard assets: property, plant and equipment. Those are fixed assets and depreciate over time. They are the assets of a manufacturing economy.

However, when you consider many of the businesses that have emerged with increasing frequency over the past few decades from start-ups to become major institutions you don’t find much fixed assets. Consider Google … Microsoft … EDS … even companies that sell hardward such as Cisco. Their balance sheets don’t reflect great value in terms of their fixed assets, because there isn’t much value in computers and desks and the other components of a knowledge-based business. But their balance sheets also don’t reflect any value at all in their core assets: their collective current and legacy intellectual capability (human assets), which actually appreciate in value over time. That raises a fundamental question: If the goal of the balance sheet is to indicate the value of the business, but there isn’t a single line item to reflect the most important assets of many of today’s most important businesses, then isn’t the balance sheet failing to achieve the reason it exists in the first place?

I think the answer to that questions is “yes,” but I do not know how to remedy the situation. I’m not certain it’s even possible to build a balance sheet for the human asset-intensive business. If that is the case, then let’s have a real appreciation for the basic flaws of the current balance sheet and lessen its importance when making decisions about such important issues as an organization’s bankability. However, rather than settling for just dismissing the issue, as many investors do now anyhow, it would be beneficial to change how we measure an organization’s net book value. That’s because the way we measure things influences the way we manage things. We shouldn’t look at the knowledge based business with the tools and mindset used for the manufacturing business. Maybe the way to do that is to scrap the current balance sheet entirely and start from scratch.

Our nation is in the midst of a massive restructuring of its banking system and the public debt market – at the least. Even if the scope of change is not expanded, the depth of the change seems to be significant enough that it would justify a reconsideration of current accounting standards. If and when that occurs, that effort should include a new look at the balance sheet.