Translating Human Capital into Financial Performance

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Companies often say “People are our most important asset”. Despite obvious flaws in both definition (unlike say computers or a factory, workers are not fixed and can walk out the door at any time) and application (how do you assign fair market value to a human being), there is common sense in this statement. Our employees drive business processes, are on the front line interacting with customers…they are the very lifeblood of a company’s revenue and profitability.

However, while saying this certainly is a testament to our employees’ value, it doesn’t say much about how they add value…and whether that can be improved.

The more interesting question is: How do we leverage this asset most effectively? When discussing assets in a financial setting, the conversation invariably turns to Return on Assets (ROA). Why is it that we rarely ask – and even less frequently quantify – the return on our human capital?

The answer is that it’s difficult. Tying individual employee actions back to company performance – to line items of revenue and cost – seems more art than science. And linking human capital strategy to financial performance often appears spurious at best. But it isn’t. There is a way to understand the impact that workforce initiatives have on financial performance. There is a way to determine the ROI of human capital.

The answer is to take a multi-step approach. Most workforce programs don’t have an easily distinguishable direct impact on financial performance. There are simply too many factors that can affect profitability, and stating that one program is attributable to a specific financial impact is exceedingly difficult. To successfully identify a workforce program’s ROI, we must establish a valid business case by creating a chain of causality…a “Human Capital Chain”…that connects workforce programs to financial results through an intermediate human capital outcome.

Human Capital Chain

Human Capital Outcomes are the intended people results of a workforce program (e.g. lower turnover, increased performance, lower time to fill, lower cost per hire, increased new offer yield, etc.).  These are often the end-goal of workforce programs for many Human Resources teams.  But as we look to improve the return on our human capital…to most effectively leverage our most important asset…we must go one step further.

So how do you do it?  There are three steps to create an effective Human Capital Chain.  This process will help you understand the financial impact of your workforce programs and create a compelling business case:

  1. Identify the Human Capital Outcome that your program affects. What people result is your program designed to achieve?  Are you trying to reduce employee turnover, decrease recruiting time or costs, improve employee performance? It’s important to note that, in reality, the Human Capital Outcome is where strategy planning should start (i.e. we need to reduce turnover, so what programs do we put in place).  But when seeking to understand the financial impact of human capital, we need to start at the activity and work our way through to the result.
  2. Quantify the effect your program has on the Human Capital Outcome. How exactly does your workforce program affect the Human Capital Outcome that you identified?  Determine a probable range of impact that your program will create. Ok, this is the hard part…but it can be done!  First, look for internal information (HRIS data, surveys, exit interviews, etc.) to establish statistical relationships.  If none available, try trusted advisors and consultants who have expertise in this field.  They can be enormously helpful and get the work done in a fraction of the time.  If that is not possible, look for valid and reliable third-party research.  Surveys with large sample sizes and robust statistical techniques (multiple regression, SEM, RWA, etc.) are best. Bear in mind, there may be more than one Human Capital Outcome for each workforce program!
  3. Calculate the financial impact of your Human Capital Outcome. What is the cost reduction or revenue associated with the Human Capital Outcome?  Using Step 2 to model the impact that your workforce program has on the Human Capital Outcome, translate this into financial terms using appropriate and commonly accepted budgetary metrics.  When the Human Capital Outcome is selected properly, these metrics become self-evident in most cases (turnover = turnover cost, time to fill = recruitment expense + vacancy cost, etc.). Remember that Financial Results are not limited to just higher revenue or lower expense.  There are four ways that a Human Capital Outcome can affect a company’s financial performance:
    1. Revenue Enhancement  (e.g. increasing productivity)
    2. Revenue Loss Avoidance  (e.g. decreasing time to fill)
    3. Expense Reduction  (e.g. reducing turnover)
    4. Expense Avoidance  (e.g. decreasing grievances)

Human Capital Chain (Example)

Following this process will give you a new understanding of your workforce and how to most effectively leverage its potential.  It adds more rigor and financial discipline to the business of human capital management.  Most importantly, this approach results in 3 essential benefits:

  1. Select the most impactful workforce programs.
  2. Demonstrate a direct link between people processes and financial performance.
  3. Identify the return on your human capital

Before you begin, be mindful of a few common pitfalls.  Most organizations fail in their mission to identify the return on human capital programs because of three general errors:

  1. Linking workforce initiatives directly to financial outcomes: Very rarely do workforce programs lead directly to a financial result.  One of a very few examples of where this is true (however unpalatable) is a workforce reduction.  Instead, most strategies impact a human capital outcome that in turn affects financial results.  It is a multi-step approach.
  2. Misunderstanding how programs impact Human Capital Outcomes: It is critical that organizations have strong knowledge – or at least an informed hypothesis – of how workforce programs impact the human capital outcomes that an organization cares most about.  Many times these impacts are wildly misstated, or even attributed to outcomes to which they are wholly unrelated.  The culprit is often anecdotal evidence…the personal experience of this manager or that.  While important to incorporate personal experience, it is more helpful to base projections on internal company data (source HRIS systems, surveys, etc.) if available or reliable third-party research.
  3. Conflating the effects of Human Capital Outcomes: Conflation – or confusing the impact of distinct relationships – can occur when there is more than one Human Capital Outcome in the chain.  This results in double-counting and can significantly over-estimate financial results.  Conflation happens because multiple Human Capital Outcomes are targeting the same result.  Let’s take an example of a Manager-led Coaching initiative (Workforce Program) that impacts both Employee Turnover (Human Capital Outcome 1) and Employee Engagement (Human Capital Outcome 2).  Various studies show that engagement impacts the organization in two ways – through employee performance and retention – so the Engagement Human Capital Outcome is conflating with Turnover and could result in double-counting turnover cost savings.  We need to either re-examine the inclusion of Engagement as a Human Capital Outcome, weight the turnover impact of Engagement (using statistical models to isolate the unique impact, or an estimation), or exclude the turnover impact altogether.

Want to learn more?  CallMe! specializes in maximizing the Return on Human Capital.  Drawing on over a decade of expertise, we help companies tap into the full potential of their most important asset.  To learn how we can help your call center, contact us at +1.877.402.2563 or info@callme.io.