ROI in HR

What is a Return on Investment in Human Resources?

Human resources is sometimes considered a “soft” industry, because it can’t always provide quantifiable financial data about its workload and doesn’t typically create revenue either. Investment in HR can make executives nervous, because projects and programs often provide no tangible results — although the idea of “improved morale” or “greater employee satisfaction” seems like a good thing, whether that translates to a significant increase in revenue or improved productivity remains questionable. Calculating the return on investment provides a way for HR professionals to demonstrate the worth of the profession.

Definition of ROI

“Return on Investment,” or ROI, is the term given to a mathematical calculation used in the finance industry and business in general. The ROI measures the financial return on an investment made, or it can be applied to a business measuring the performance of the firm by assessing the net profit compared with the overall net worth of the company. In more recent years, the ROI concept has been adopted by other industries to evaluate projects and programs on a smaller scale.

Importance of ROI to HR

Using quantifiable metrics improves the credibility of HR as a profession, and allows upper management to identify specific, measurable ways that HR services benefit the organization. It’s no longer enough to state that a certain program is believed to be beneficial — you need to be able to prove the worth of your actions. In difficult economic times, the value of support services — often seen as tangential to the organization’s core mission or product — comes under increasing scrutiny. Consequently it becomes even more important for HR professionals to show how HR services directly impact the bottom line, while identifying and eliminating programs that are not financially efficient.

Examples of ROI in HR

HR can use ROI metrics to analyze the value of almost any of its services, as long as a dollar cost can be determined. For example, if HR introduces a new health and safety program, its effectiveness can be measured by the associated reduction in costs of work-related injuries. The value of a new employee orientation program can be measured in terms of an ROI by assessing the costs saved by correlated reductions in turnover. Diversity programs, HR information systems, training, development and mentoring initiatives are additional examples of HR programs that can be measured by the ROI calculation.

Calculating ROI in HR

To calculate the ROI of human capital, divide the organization’s net revenue — gross revenue after deducting operating expenses, salaries and benefits — by the cost of salaries and benefits. To calculate the ROI of a particular program, you must first calculate the value of the specific program itself, then divide it by the costs of implementing the program. For example, if a training program to speed production of a factory line results in an increased amount of product, calculate the value of the additional product and divide that by the costs of providing the training and materials. In some cases — a general increase in productivity, for example — you will need to isolate the portion of the increase that was because of an HR measure before calculating ROI. Conduct an analysis of groups that underwent a training class, versus groups that did not, to estimate the effect. Alternatively, use an expert to estimate the percentage increase that was because of the training.

A company is only as good as its employees. Most employers have heard this quote, or some variation of it, which is one reason the scramble to find talent is so important. And when you do hire employees, you want to make sure your business benefits from them.

You don’t want to spend thousands of dollars on an employee’s wages unless they positively impact your bottom line in business. Human capital metrics show you the value an employee adds to your company by quantifying performance.

What is human capital?

As a business owner, you constantly invest in your company. You hope that your investments will lead to more revenue and faster processes. To find out if your investments are worth your trouble, you measure how much money your new assets bring your business.

Human capital is the value an employee’s skills, knowledge, and experience add to your business. You invest in your company every time you hire a new employee.

Hiring and training costs can be offset by the value an employee returns to your business. Investing in an employee is not the same as buying a piece of equipment, but you should still be able to measure the value they add to your company. Being able to quantify how employee performance and hiring costs affect your bottom line is an important part of managing your books.

You need to see how much value the employee adds to your business by measuring human capital. It’s also important to see how much you invest in each employee.

Use metrics that measure human capital value to answer questions like, “Does my employee bring in more money than what I pay them?” and, “How much did I invest in training each employee?”

3 helpful human capital metrics

Deciding to create a human capital valuation model can be very beneficial to your business. Learning how to measure human capital can help you make hiring, training, and promotion decisions.

Here are three important metrics related to human capital you should be tracking.

Human capital ROI

The human capital ROI is the main measurement of human capital that business owners use to compare an employee’s value to their expenses.

Human capital ROI (return on investment) is a ratio that shows you how much your business earns compared to employment costs. You can use this to see how much is returned for every dollar invested.

Employment costs can include things like salaries, health insurance premiums, retirement plan contributions, and education assistance.

Here is the formula for the ROI of human capital:

Human Capital ROI = (Revenue – Operating Expenses – Employee Compensation) / Employee Compensation   

For example, you want to find your human capital ROI for October:

• Your business brought in $80,000 in revenue.
• Your operating expenses were $30,000.
• You paid your employees a total of $20,000 in wages, and you had $9,000 in benefit costs for a total of $29,000 in compensation costs.

($80,000 – $30,000 – $29,000) / $29,000 = .72

Your human capital ROI was .72, or 72%. This means you had a return of $0.72 for every $1.00 invested.

Training investment value

If you want to see how much money you spent on each employee for training, use the training investment value. This will show how much money you invested into human capital.

The formula for training investment value is:

Training Investment Value = Total Training Investment / Headcount

You will need to know how much you spent on training as well as how many employees went through the training.

Let’s say you hired four new employees and spent a total of $10,000 on training. Your training investment value would be:

$10,000 / 4 = $2,500

You invested $2,500 into training each new hire.

Turnover rates

As an employer, you know that hiring and training expenses can add up. After pouring money into an employee, you don’t want them to leave. Knowing how to calculate turnover rates can show you what percentage of your workforce leaves during a specific time period.

Here is the turnover rate, or voluntary separations, formula:

Turnover Rate = (# of Separations / Average # of Employees) X 100

For example, you want to find your turnover rate from January to July. You had four employees leave, and your average number of employees was 25.

(4 / 25) X 100 = 16%

Your turnover rate was 16%. That means that 16% of your workforce left during this time period. You would need to spend money replacing the employees who left your business.

Accounting for human capital

Don’t forget about the value human capital adds to your business. By using human capital measurement metrics, you will have a greater understanding of how your employees impact your accounting books for small business.

Employees are listed as an expense in your books. But with a human capital asset management system, you view your employees as assets.

When you lose an employee, you don’t just lose an expense. You also lose a valuable asset to your company. Invest in employees with successful training, educational assistance, and easy-to-use technology.