Return on Invest - ROI of Human Capital

 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.