In today’s competitive labour
market, the human resource (HR) department would have to be an active
department that has risk management functions. Also because competitors are
forever raising the bar, there is the need for HR to be analytic and strategic.
The degree to which Return on
Investment (ROI) overstates the economic value depends on at least 5 factors:
1. Length of life (the longer, the
larger the overstatement).
2. Capitalization policy (the
smaller the fraction of total investment capitalized in the books, the greater
will be the overstatement).
3. The rate of life which
depreciation is taken in the books (the depreciation rate drops nearer than
straight-line and will result in a higher ROI).
4. The time between the date of the
investment and the payback of the investment from cash inflows (the greater the
time, the greater the degree of overstatement).
5. Companies that grow too quickly
will more than likely have a lower ROI.
ROI Formula: How
to calculate some of the key strategic Human Resources metrics:
Measure - Human Capital ROI
Formula -
Revenue – (Operating Expenses – Compensation + Benefits Costs) / Compensation +
Benefits Costs
Value/Use -
Allows determination of return on human investments relative to productivity
and profitability; represents pre-tax profit for amounts invested in employee
pay and benefits after removal of capital expenses.
Measure - Profit Per Employee
Formula -
(Revenue – Operating Expenses) / Number of Full-time equivalent (FTE)
Value/Use -
Illustrates the value created by employees; provides a means of employees
productivity and expense analysis.
Measure - HR Expense Factor
Formula -
Total HR Expense / Total Operating Expenses
Value/Use -
Illustrates the degree of leverage of human capital; provides a benchmark for
overall expense analysis relative to targets or budgets.
Measure - Human Capital Value Added
Formula -
Revenue – (Operating Expenses – Compensation + Benefits Costs) / Total number
of FTE employees
Value/Use -
Shows the value of employee knowledge, skills and performance and how human
capital adds value to an organization.
Measure - Turnover Rate
Formula -
Number of employee separations (during a given time period) / number of
employee
Value/Use -
Provides a measure of workplace retention efforts which can impact direct
costs, stability, profitability morale, and productivity; can be used as a
measure of success for retention and reward programs.
In general, in order to calculate a
return on investment (ROI), the total profit generated must be divided by the
total value of the assets used in creating that profit.
Formula: ROI = Net Income / Value
of Assets
Formula: ROI = Income / Value of
Assets
Better alternative: ROI = Net
Income + Interest (1-Tax Rate) / Book value of Assets
HR ROI = Results (actual
performance or expectations) / Salary + human resource development
investment.
However, HR is usually nonprofit
generating, and from this stems the difficulty in assessing its ROI within a
company. So, to assess the value that HR can bring, one must look at the role
that HR plays in increasing a company’s profits.
One of the most important roles of
HR is the recruitment and training of a
company’s employees. The more sensitive and active an HR department is in
promoting, training, and in general being open and listening to the needs of
employees, the greater the value the company will receive from its workforce.
Contented, happy employees directly influence a company’s productivity.
Therefore, to calculate the return on investment in HR, one should look at the
relationship between the sales value derived from each training day and the
total number of the training days involved, and dividing the result by the
total cost of training. Basically, one is assessing the investment in human
capital by considering the cost of training programs per employee, and trying
to determine how much more revenue this has brought to the company.
