Human capital impact to business results

Human capital impact to business results
Financial planning

In the classic business literature it is hard to find the clause about the competences and the value of know how in end results. Since ideally it is assumed that businesses are managed with high experienced managers and enterprise has/can get all competence assets any time. This makes our university level of business education much more easy, where with quantitative terms we can relate the inputs and outputs to each other. Every business is a promise to earn more profit on current assets much more than other ones. That’s why one company can attract funds and another is challenged, since everything is about the guess of whether will it work or not question. Unfortunately in real business environment it is not that easy to input money, do your stuff and earn money. Companies compete in different dimensions including resources (asset, human, environment, e.t.c) and customers. Also , companies need to have right decisions on right times. So in overall if we look into the enterprise from limited resources side , it is much more challenging that books have been telling us for so much time.

Leveraging the business performance

Just imagine a car, with dashboard, steering wheel, windshield, seats, gearbox and everything else what you can see in a car nowadays. Although it is ideally arranged and built masterpiece of machinery, but, without a real outcome of taking people from A to B, its value is only the sum of metal and plastic value it is prepared from. So at first step we have to understand that, when we evaluate the car we do not calculate the cost sum of materials it is build of, instead, we pay for the way of its arrangement and idea, knowhow and further more features that are designed to add value to our experience. So even if material price of 2 different car brands can be the same, but the , real retail price can vary in times. This is the price what we pay for the knowhow and the value that car manufacturer prepared for us. Or simply we can define it as brand value of the company. If we relate that car to business, the business is not only the total of assets that it has. No, but it is a total of everything, including the power of design, engine and future promises. Thats why when we evaluate the companies, we get so much intangible value over the assets that it has.

In the next step lets agree that there is not totally ideal car design so far, since, always there is a thing that someone can make better. Even do, the key principles of the cars are many decades are the same, cars are in constant evolution. Earning money is not new profession, it is part of nature of human beings. Working, generating the value and being part of the economy. So as in cars, the key principle of making business is still the same as, investing into something , working over it and getting the value back by selling it. What currently matters is how it is done and whether the difference makes you ahead of competition in different markets.

Human capital leverage

The third point is , and , the most essential I’d say is human factor. The people who drive car, run business. Car has its dashboards, several manual and a lot of the automatic handles to manage it, avoiding crashes and being able to get in shortest time to destination. Without a human it is almost impossible to run a car, since it needs a control and different actions upon the different environmental situations linked to each dashboard indicator. In business it is also the same. Driver, not only responsible to evaluate environment outside of the car, but also, dashboard indicators to make sure that car runs smoothly. Otherwise, whether car can get wrecked or run into the accident. If we draw a parallel to the business world, it is also the similar as in car example.

We cannot imagine a company whose management only focused to internal indicators, otherwise it will have fatal ending for the company. Management is responsible to evaluate all internal and external business data and act upon best experience. The same applies to the all staff to carry their jobs in perfection. They also need to manage their data and act intelligently over that.

In April 1999, investment bank Goldman Sachs launched an initial public offering (IPO) that drew a market value of $36 billion on its opening, a value four times that of its hard assets. If we subtracted the book value from the $36 billion and divided that by the number of employees at the time of the IPO, we would see a dramatic example of the market appreciation for human capital leverage. Ref:The ROI of Human Capital, Jac Fitz-enz

In upper example we obviously see and obvious example how knowhow can build value on image of company. Unfortunately there is limited of this  Peter Ferdinand Drucker , one of the best-known and most widely influential thinkers and writers on the subject of management theory and practice, claims that the greatest challenge for organizations today and for the next decade at least is to respond to the shift from an industrial to a knowledge economy. As in the car example the only thing in the driving car which Is active is human capital which can leverage your business, your driving in times. Otherwise the basics of all business models are the same. Drucker also expresses that the shortage of tallents will be felt more by companies during the next decades, but unfortunately most companies are challenged for business results considering internal data, but the opportunities are really outside.

Added value of Human capital to businesses

As we see that the main leverage generators for the companies are people. Now the biggest question is how to measure, and evaluate added value by human capital to the companies. There are several international organizations who are closely working on these terms. Lets go over several of the indicators which will help us evaluating and measuring the impact of know-how at companies.

  1. Human Economic Value Added (HEVA)
  2. Human Capital Cost Factor (HCCF)
  3. Human Capital Return on Investment (HCROI)
  4. Human Capital Market Value (HCMV)

Human Economic Value Added (HEVA)

This term is popularized by the organization of the Stern Steward, especially for the economic added value. The main principle here is about the deduction of cost of capital from the net operating profit and divide it by Full Time Equivalent(FTE-amount of total workforce used)

HEVA = ( Net Operating profit after taxes – Cost of capital ) / FTEs

This is very good indicator that how much the workforce generate the leverage for the earning power of company. If we see that number is growing that means we can afford more investment to the employee. Also it is sign of that how much intensively human resources are used. The more the value , to more effectively know-how is used and impacting the business.

Human Capital Cost Factor (HCCF)

There are mainly 4 different cost accounts for the human capital. They are salaries, benefit costs, pay costs for contingents, cost of absenteeism and cost of turnover. If we calculate and summarize all of those costs we can come to the number which is absolutely different what we expect as the cost, the costs. As it is seen from the formula the amount of contingences and the absences what appears in company also affects the efficiency.

Human Capital Return on Investment (HCROI)

Of course, calculation of the “Return on Investment” has been there for a long time. For human capital, justification of the human capital costs can be good reasoning for the management. Lets see how this indicator can be calculated. The formula for HCROI is as follows :

HCROI = (Revenue – (Expenses – Pay and Benefits)) / Pay and Benefits

For every dollar spent on human costs with no change in total expense, we got a smaller human capital profit ratio. Now that you see the logic, you can design additional metrics that include training and other employee-related costs to suit your special needs.Ref:The ROI of Human Capital, Jac Fitz-enz

Human Capital Market Value (HCMV)

This indicator is more targeted to evaluate the value of human capital accumulated in the company. Actually in this terms the human capital contains much more intangibles including the process capability, brand value or marketing acumen.

So here the formula is straight forwards as,

HCMV = (Market value – Book value) / FTEs

So, this calculation gives you idea about, how much intangible assets you own per one employee. Actually here are the different biases possible since the market value of company can vary very dramatically because of the economic situations, e.t.c Therefore it is better to measure this constantly over the time to have a good linkage to the base.

How to monetize better over human capital?

I will always defend the idea that best people make best results. Thats start of every activity. 80% of success of having right people in your organization is linked to your procurement door. Characteristics of people you hire, that will draw 80% of your future picture. Do not believe that people will change over time. in 90% of cases it does not happen. Therefore hire best people from the start and make sure that they are involved into the process of your production. There are many cases when the best football players sit on replacement benches over the season. Therefore corporate human capital base followup should be done on management level not fully delegated to some functions as HR or given free environment.

References :

  1. The ROI of Human Capital, Jac Fitz-enz
  2. Human Capital Management: Achieving Added Value Through PeopleAngela Baron and Michael Armstrong
  3. Interviews with HR personal.