Category: Management Notes

Management Notes

Areas covered by HR Audit: Pre-employment Requirements, Hiring Process, New-hire Orientation Process, Workplace policies and Practices

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(1) Planning:

Planning is one of the major areas where human resource audit can be conducted. Planning of HR requirement and effectiveness of forecasting and scheduling can be ascertained through HR audit. It is to be seen whether the needs of HR were identified in time or not. If there is an indication through audit about inaccurate forecast, the efforts can be made to improve the forecasting techniques for accurate results in future. Through audit management knows whether there is surplus or shortage of manpower.

A review of recruitment and selection practices can be made to meet the future HR requirements. Better programmes and procedure can be adopted by way of cost benefit, budgets. The training programmes can be reviewed in terms of results obtained. Motivation of employees at all levels is the key aspect in HRM. Evaluation of employee motivation will show whether they feel at ease at work and have better prospect if they work hard.

HR auditors should evaluate the communication in the organisation which is one of the major criteria of failure or success. HR auditors should find out the causes of absenteeism, rate of accidents, labour turnover and can make suggestion to improve them. In respect of all these appropriate policies can be formulated by the management.

(2) Staffing and Development:

Staffing and development is yet another are a need to be evaluated with reference to results obtained, programmes and procedures adopted and policies framed. Staffing is done through recruitment and selection. Here the HR auditors need to evaluate the sources of recruitment and the number of persons hired by the organisation. The success of these programmes depends upon the contributions made by the hired persons in the achievement of organisational objectives.

Auditors have to see whether committed workforce is procured through recruitment and selection programmes. They can then make appraisal of recruitment and selection policies, practices and results. As for results are concerned they depend upon the effectiveness of H.R. policies and practices adopted by the enterprise. For conducting the audit of results the HR auditors need to adopt the methods such as questionnaires, checklists, personal data, and attitude and morale surveys productivity data, and costs, time.

The auditors should thoroughly check the records and statistics and should stress on their accurate maintenance. The information in respect of disciplinary actions, absentees, transfers and promotions are available in records. HR auditors have to examine the procedure and programmes adopted in respect of career and succession planning. The policy for staffing should be formulated in to achieve organisational goals. In this case cream should get due consideration that too without any discrimination.

As for training and development, proper policies need to be formulated by making the SWOT analysis of the existing staff and training and development programmes should be prepared to meet the organisational needs. The cost of training is increasing day by day.

Hence there must be evaluation of specified training and development programme. Auditors should see whether the best practice is adopted or not. They should evaluate the training results in terms of cost per trainee hour, average training hours per employee and revenues per employee per year etc. They can obtain the feedback from reports and records available in the organisation.

Another main element of conducting an HR audit needs to include the effectiveness of the HR department’s people management activities. Areas for auditing under people management include staff performance and employee morale, department organization, responsiveness to employees, day-to-day HR operations, the department’s HR strategies and more.

(3) Organizing:

Organisational structures are meant for facilitating coordination, communication and collaboration. HR auditors have to evaluate effectiveness of organisation structure in attaining the results. They can obtain feedback from the employees and from reports and records. They can check the jobs assigned to the individual employees, authority delegated to the subordinates, special task forces etc. H.R. auditors can also evaluate the policy formulated for encouraging employees to accept change. They can also verify effectiveness of three way communication.

(4) Commitment:

Enterprise wants committed employees. Efforts are taken by the management in this respect for motivating individual and groups of employees. HR auditors have to examine the results of motivation through increase in productivity, improvement in performance and costs. They also have to examine the programmes and procedures followed for job enrichment, wage and salary administration, fringe benefits, morale of employees. They have to verify the satisfaction level of employees through the HR policies adopted by the organisation. A satisfied employee is committed to the work.

(5) Administration:

HR auditors have to examine the style of leadership adopted by the management in dealing with the subordinates. Leadership may be authoritative or participative should be evaluated. One of the benchmark in this respect is delegation of authority.

Delegation is more in participative style. Auditors can assess the results of style of leadership adopted in getting the things done through others by inviting suggestion, going through grievances of the staff, disciplinary actions taken against the subordinates etc. Leadership results can also be visualized if auditors examine the union management relationship and the employees getting promotions.

The auditors also have to examine the position of collective bargaining and its procedure to assess the effectiveness of administration in the organisation. They have to look at the policy of the management in respect of collective bargaining and employee participation in decision making.

(6) Research and Innovation:

Research and innovation is yet another area of HR audit. Here several experiments are conducted and theories are put to test by the experts relating to quality design, marketing etc. Results obtained through this Endeavour can be evaluated on the basis of changes brought about, experiments made and reports and other similar publications.

Auditors can evaluate the results. They can also examine the programmes and procedures adopted for R and D efforts. The management’s policy in respect of R & D efforts can be examined by the auditors and necessary suggestions can be made by them in this regard.

Management Notes

Method of conducting HR Audit: Interview, Workshop, Observation, Questionnaire

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The purpose of the audit is to reveal the strengths and weaknesses in the organization’s human resources system, and any issues needing resolution. The audit works best when the focus is on analyzing and improving the HR function in the organization. The HR audit itself is a diagnostic tool, not a prescriptive instrument.

It is most useful when an organization is ready to act on the findings, and to evolve its HR function to a level where it’s full potential to support the organization’s mission and objectives can be realized.

An organisation has tended to grow bigger, so have the staff departments along with line functions. A time comes when each of them becomes so big that one does not get a fair idea of how they are doing unless special effort is made and studies are undertaken. For the line functions, some indices are available.

In production, for instance, performance can be judged by how much was produced, to what extent schedules were adhered to, at what cost manufacturing was done, what was the unit cost, etc. These figures in themselves are important and they take added meaning when they are compared with, say previous year or years or with the planned and budgeted figures.

Similarly, marketing departments efficiency can be judged by the quantum of sales, sales vis-a-vis competitor’s sales, cost of sales, territories covered, new customers explored, old customers retained, etc.

In case of departments like HR such yardsticks are not readily available. Essentially they have to be evolved according to an organisation’s requirements. Today personnel departments have become big and employ sizable staff and specialists. As such, some kind of audit needs to be undertaken to secret in the functioning of the department. Hence, HR audit comes in the picture.

Method

HR audit is a tool to measure the level of human resources development system.

  1. Interview Method:

Top management and senior management (Line managers and employees) are interviewed by the HRD auditor. It is a structured interview designed to solicit information on the perspectives of respondents on the future growth plans and goals of the organization, organization culture, working style, career development, work flow system, leadership style, morale, motivation, vision, mission etc. In view of the time and resources constraints, HRD auditor uses sampling techniques to interview the employees.

  1. Questionnaire Method:

HRD auditor designs and administers structured questionnaire to assess the various dimensions of HR development. It is usual practice to test the reliability and validity of the instrument using appropriate statistical technique by conducting a pilot study. Then he has to choose the proper sample size. The questionnaire should accommodate questions reflecting the objectives of HRD audit. It is given to the sample respondents who have to record appropriate response.

  1. Observation Method:

HRD manager observes the employees in their natural environment i.e., workplace, canteen, training camps, residential colony to assess the suitability and conduciveness of environment for human resource development.

  1. Desk Research Method:

HRD manager collects and uses details relating to performance appraisal report, ethical practices, achievement records, welfare measures, suggestion scheme, career development, frequency of training programmes, feedback of participant trainees, methods used to ascertain training needs, safety practices, accident prevention, incentive and compensation system, etc. He analyses the facts and figures relating to aforesaid areas and arrives at appropriate findings.

This method does not involve interviewing the respondents through a questionnaire or an interview schedule. The entire information is gleaned from the relevant records of the organization.

  1. Workshop Method:

Employees are selected either through a sampling technique or through some other norms, for participation in a workshop conducted exclusively for HRD audit purpose. All the participants selected are divided into groups. Different dimensions of HRD are assigned to different groups for SWOT analysis. Then each group is required to prepare a report and make presentation on the themes assigned. The outcomes of the report of each group are deliberated deeply and suggestions are made to the organization. The whole exercise is moderated by the HRD auditor.

  1. Task Force Method:

A task force comprising different experts from various domains in the organization is constituted to identify, evaluate and recommend an appropriate solution to the HRD problems identified. HRD manager can work on the accepted recommendations for further development.

Management Notes

Principles of effective Human Resource Audit

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The P4 (Policies, Programmes, Practices, People) HR concept re­quires to be audited time to time. This will lead to maintain to growth and development of the organization. If you are guiding your HR func­tion through compliance and employee relations issues, you know how challenging your work can be.

With the Human Resource Audit, you can determine where you are, prioritize what you have to do and know for certain you have looked at the right issues. Your comfort level and profes­sional contribution will be confident about moving forward.

Human resource audit means the systematic verification of job analysis, job description, job design, records of recruitment and selection, orientation and placement, training and development, job evaluation, performance appraisal, motivation and moral, compensation packages, welfare and social securities as well as industrial disputes and their solutions.

HR audit is very much useful to verify the HR practices and a vital tool which helps to assess the effectiveness of HR functions and performances of an organisation.

An audit is a review and verification of completed transactions to see whether they represent a true state of affairs of the business or not. Thus, an audit is an examination and verification of accounts and records.

Human Resource (HR) audit refers to an examination and evaluation of policies, procedures and practices to determine the effectiveness and efficiency of HRM. In essence, HR audit refers to:

(i) The measurement of the effectiveness of the HRM’s missions, objectives, strategies, policies, procedures, programmes and activities and.

(ii) The determination of what should not be done in the future as a result of such measurement.

Principles

(i) Define the role of the HR function in the context of the organization’s current and future business plans.

(ii) Create a system for cost-effective hiring.

(iii) Develop programmes for the orientation and training of new employees.

(iv) Develop and manage employee communication.

(v) Prepare key personnel policies and make it available to employees and also train the employees in policy adherence.

(vi) Implement and install the HR IS system.

  • Need for independence.
  • Audit activities should be budgeted properly.
  • Acknowledgment that there are many types of audits.
  • Each type of an HR audit has its own goal, scope and might use different methodology.
  • Established time frames for every phase/step of the audit.
  • Trained auditors.
  • Set standards for HR auditing.
  • Reporting template and final audit report.
  • Auditors should sign NDAs and keep information confidentiality.
  • Auditors should agree preliminary on communication strategy.
Management Notes

Role of HR Auditor

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HR audit is a functional audit. It consists of diagnosing, analyzing, evaluating and assessing future lines of action within the framework of HRM. HRD auditing is a basic tool for the management of a company. Its objective is not only the control and quantifying of results, but also the adoption of a wider perspective that will aid in designing future lines of action in the HRD field.

Thus, HR auditing must perform two basic functions, 1st; it must be a MIS, whose feedback provides information about the situation in order to facilitate the development of managing processes or the development of HRD. On the other hand, it must be a way of controlling and evaluating the policies that are being applied, as well the established process.

Types of Audits

An HR audit can be structured to be either comprehensive or specifically focused, within the constraints of time, budgets and staff. There are several types of audits, and each is designed to accomplish different objectives. Some of the more common types are:

  • Best practices. Helps the organization maintain or improve a competitive advantage by comparing its practices with those of companies identified as having exceptional HR practices.
  • Focuses on how well the organization is complying with current federal, state, and local laws and regulations.
  • Function-specific. Focuses on a specific area in the HR function (e.g., payroll, performance management, records retention).
  • Focuses on strengths and weaknesses of systems and processes to determine whether they align with the HR department’s and the organization’s strategic plan.

However, organizations are particularly vulnerable in certain areas. Most lawsuits can be traced to issues related to hiring, performance management, discipline or termination. Some additional risk areas that employers should carefully review in an audit include:

  • Misclassification of exempt and nonexempt jobs. Almost every organization has job positions that have been misclassified as exempt from overtime eligibility. The complexity of wage and hour laws and regulations makes it easy to err in classifying a job as exempt, thereby exposing the employer to liability for past overtime.
  • Inadequate personnel files. A review of sample personnel files often reveals inadequate documentation of performance for example, informal, vague or inconsistent disciplinary warnings. Performance evaluations may be ambiguous, inaccurate or outdated. Personal health information is often found in personnel files, despite medical privacy laws requiring such data to be kept separate. Accurate and detailed records are essential for employers to defend any type of employee claim, particularly unemployment compensation or wrongful termination claims.
  • Prohibited attendance policies. Controlling excessive absenteeism is a big concern for most employers. However, the complexity of family and medical leave laws, with sometimes conflicting state and federal protections, has made many formerly acceptable absence control policies unacceptable. Absences affect workers’ compensation, family and medical leave, disability accommodations, and pregnancy laws. Organizations often have attendance policies that do not comply with relevant laws and regulations or that grant employees more protections than required.
  • Inaccurate time records. Employers typically require nonexempt employees to punch a time clock or complete time sheets reflecting their time worked each week. The records generated by these systems typically are the employer’s primary means of defense against wage and hour claims, so time-keeping policies and practices must be clearly communicated and consistently administered.

The HR audit process is conducted in different phases. Each phase is designed to build upon the preceding phase so that the organisation will have a very strong overview of the health of the HR function, at the conclusion of the audit. These phases include: Pre-Audit Information: This phase involves the acquiring and review of relevant HR manuals, handbooks, forms, reports and other information. A pre-audit information request is forwarded to the client who compiles the necessary information for review by auditors. Pre-Audit Self-Assessment: In order to maximise the time spent during subsequent portions of the audit, a pre-audit self-assessment form, if sent to the client can be of use.

The self-administered yes/no questionnaire asks a number of questions about current HR policies and practices. The completion of this self-administered questionnaire allows auditors to identify key areas for focus during the HR audit.

On-site Review: This phase involves an on-site visit at the client’s facility interviewing staff regarding HR policies and practices. A very in-depth HR audit checklist is completed.

Records Review: During the on-site visit, a separate review is conducted of HR records and postings. Employee personnel files are randomly examined as well as compensation, employee claims, disciplinary actions, grievances and other relevant HR related information are checked.

Audit Report: The information gathered is used to develop an HR audit report. The audit report categorises action needs into three separate areas. The areas that are urgent and important (UI), not urgent needs but important (NUI), not urgent but not important needs (NNI), and important opportunities needs (IO). As a result of this scheme of classification, managements can prioritize their steps.

The critical areas the, comprehensive HR audit covers all areas of HR management like recruitment practices, training and development, compensation and benefits, employee and union relations, health, safety and security, miscellaneous HR policies and practices-welfare, strategic HR issues, manpower planning/budgeting. Besides classifying needs in each of the above areas, the HR audit also cites relevant laws, cases and research to support the recommendations.

Preparation for an audit Auditor engagement: If external firm carrying out the audit, it is preferable to set terms in writing defining and agreeing on scope. If using internal resource it is better to appoint them formally with clarity on scope and select persons who are nonpolitical or those who are not high on hierarchy. Also, if internal persons are auditing there must be training in auditing.

Documents, manuals, handbooks, forms and reports auditor must have access to relevant information contained in employee files and other confidential documents of the organisation. Auditors must be given unrestricted access to records, once they sign agreement for confidentiality.

Data gathering: Completion of a self-assessment questionnaire significantly expedites the audit process and allows for better audit planning.

Audit of the HR policies and practices is the assessment and evaluation of the conventional HR practices being followed in an organization. These include:

  • Staffing: Assessment of methods and procedures used in recruitment; recruitment costs; recruitment efficiency in filling vacant positions; efficiency of selection procedures.
  • Workforce planning: Assessment of existing resources; future personnel requests; analysis of succession plan; and staff turnover analysis.
  • Performance management: Analysis of methods used in the personnel assessment; assessment of results and effects of the personnel evaluation process.
  • Compensation and benefits: Analysis of motivation forms; their relationship with personnel motivation; analysis of the level and structure of compensation.
  • Training and development: Analysis of targets and forms of training; study of the training program; assessment of personnel after completing training; the efficiency and results of the training program; analysis of development system of personnel in the organization; job analysis; analysis of the plan for personnel development.
Management Notes

Benefits and Limitations of Human Resource Accounting

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Human Resources Accounting is involved in identifying, measuring, capturing, tracking, and analyzing the potential of a company’s human resources and communicating the resultant information to the stakeholders of the company.

It is a process of measuring the cost and value of human resources (employer and employee) and delivering this information to concerned parties. Human resource accounting measures expenses associated with human assets in recruiting, selecting, hiring, training and developing them. This accounting term determines the present economic value of all its employees and managers.

Benefits:

Communicates Information to Investors

It delivers all relevant information to investors. Human resource accounting analyses and prepares reports about manpower working in the organisation and present this report to all concerned parties. These reports clearly depict the productivity of manpower which can be used in determining the true picture of the business state. Investors can easily determine profitability and future growth aspects of business and accordingly take their investing decisions.

Motivates Employees

Human resource accounting helps the organisation in taking all necessary steps for the growth of its employees. It tells the organisation full details about its employee’s affairs and their condition. This helps in designing various welfare programmes by business which improves their satisfaction level. Employees feel that the company cares for them which boost their morale and motivates them to work hard towards their roles.

Designs Training And Development Programmes

Human resource accounting helps in designing proper training and development programmes for employees. It helps in measuring the output by recording and analysing all data about manpower. Inefficiency of employees can be easily detected. This helps in providing training and education to all employees according to their skills and experience.

Better Manpower Planning

Human resource accounting helps organisations in properly planning and managing their human resources. It records each and every detail about manpower working with the organisation. It measures the cost and value of human resources as well as determines their strengths and weakness. All the information collected and recorded is communicated to management from time to time. This helps management in taking right decisions and better planning of human resources.

Attracts Best Manpower

Human resource accounting is practised by reputed and big corporates. Implementation of Human resource accounting improves the goodwill and image of business. Many talented and competent employees want to be the part of these reputed companies. This, therefore, helps in attracting and retaining the best manpower in business.

Formulates better personal Policies

Human resource accounting helps in the formulation of better policies for human resources. It supports the managers in framing policies related to promotion, transfer, job satisfaction, favourable working environment etc. Management gets full details about all employees through human resource accounting which helps them in framing strategic policies as per the requirement of time.

Proper Utilization of Human Resources

Efficient utilisation of manpower is important for every business. It has an efficient role in increasing profitability and productivity. Human resource accounting aims at increasing the efficiency of human resources. It helps in monitoring the activities of manpower by supplying relevant information to managers. Different steps are taken by management from time to time to improve their performance as per information provided to them.

Limitations

Unrealistic Valuation

Human resource accounting seems to be unrealistic approach of valuation. The lifespan of human is uncertain and it cannot be estimated at all. Taking assumption on human life may go wrong at any time thereby resulting in false results.

No Evidence

There is no proper empirical evidence available till yet to prove the utility of HRA. It is a hypothesis that HRA acts as managerial tool which facilitates the effective and better management of employees.

Absence of Standardized Procedure

The human resource accounting does not have any standardized procedure of valuation. It lacks universal acceptability of principles unlike conventional system of accounting. The methods of human resource accounting lack wider acceptance which avoids uniformity. Moreover, the principles are based on various assumptions that may prove wrong at any point of time.

No Clear-Cut Guidelines

Human resource accounting lacks clear cut guidelines on how to differentiate the ‘cost’ and ‘value’ of human resources. There are many drawbacks present in the system used currently for valuing human resources. Life of human is uncertain and therefore valuing them like assets under such foggy conditions is improper. The human resources unlike other physical assets cannot be owned, retained and used as per the pleasure of organization. Also, human resources may leave the organization after getting valued. It is not an easy task to value human resources under such conditions.

Idea May not be Accepted

There is a fear that trade unions and employees may not accept the idea. There may be a division of employees due to their valuation at different levels as those who are low valued may feel discouraged. Trade unions may disapprove idea on the fact that employees will be rewarded on the basis of their valuation in organization.

Dehumanize Human Resources

The valuation of human resources may result in dehumanizing and manipulating the employees. Persons who are given low values are demotivated or discouraged which adversely influence their competencies in work. A feeling of jealousy may erupt among employees when they came to know the differences in relative values leading to disturb the team solidarity.

Measurement Problems

Another major drawback in accounting of human resource is the presence of numerous measurement problems. There is no agreement in between the finance professionals and accountants with regard to method of measurement. The manner in which human resources should be valued and shown in balance sheet is not specified. In addition to this, problems are further compounded due to question of amortization/recovery rate.

Management Notes

Cost of Human Resource: Acquisition cost, Training and Development cost and additional cost

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Measuring Human Resource costs (HR costs, also called Human Resource costing), is a key component of HR accounting. In this article, we’ll explain what Human Resource costing is, why you should measure costs, how to do it and why just measuring Human Resource costs is not enough.

Reasons

  • Predict future costs
  • Monitor departmental costs
  • Calculate a return of investment (ROI)
  • Measure impact and overall success

Remuneration: Remuneration costs include basic pay, dearness allowance, city compensatory allowance, house rent allowance, conveyance allowance, etc. However, these are paid remuneration costs. Organizations are also required to cater for deferred benefits to employees. Certain statutory payments to employees are also accounted under this head, like, contribution to provident fund, pension fund, medical benefits, payment for holiday, sickness, bonus, etc. To retain and attract talent, organizations may also give various fringe benefits to their employees. Even the latest practice to provide stock options to employees involves certain opportunity cost to the organization. The best practice is to delineate such cost elements and arrange the same in the form of a spread sheet. Element-wise cost trends then can be studied over the years and also can be bench-marked with other comparable organizations to understand the nature of variance and to enforce control, wherever necessary.

Recruitment: Recruitment cost is also another major cost head for HR. Right from developing job specifications to describing job requirements, it includes costs of  recruitment, promotion (through advertising), head hunting, evaluation, interviewing, induction and orientation. A well defined job specification minimizes the search for the right fit and consequent costs. If recruitment plans are to meet short-tern-requirements, it may be better to outsource than go in for direct recruitment. There are many specialized manpower agencies, which make people with required skill sets available on contractual terms. Similarly, internal hiring also needs to be explored vis-a-vis external hiring. Internal hiring involves restructuring and relocation costs, a clear policy on ‘promotion from within’ (wherever recruitment is made for the higher posts), etc. A detailed study on cost of hiring is necessary to explore an alternative recruitment process.

Training Costs: Training costs include, cost for induction period, cost of remuneration for the trainee and trainer, cost of travel for the trainee and the trainer, if any, cost of training materials, imputed cost of machines and equipments, used during the training, cost for development of training modules, cost of training evaluation, cost of material wastage during training, if any, cost of production loss for the trainee and the trainer (if he is within the organization, for in-house training), etc. To accurately ascertain cost of training, it is necessary to develop a checklist or a worksheet, delineating all direct and indirect costs of training. There are various methods of training delivery, which we have discussed in previous posts: Different employee training & development methods. Relative benefits and costs of each such method also need to be weighed to understand the most cost-efficient system. Any training on skill renewal needs to be weighed in terms of expanded skill cycle of the trainees. If the trainees are in the higher age bracket or due to retire within a short span, then offering them voluntary retirement (VR) may be more cost effective than putting them on training for skill renewal and skill change.

Relocation Costs: Many organizations have their policies on periodic relocation of employees as part of their restructuring exercise. This is more appropriate for those who have their units in multiple locations. Such decisions from organizational point of view, involve cost related to disturbance allowance, cost of possible litigation, cost of housing, cost of travel, etc. Many departmental undertakings and public sector units thoughtlessly relocate their employees adding costs to the exchequer. Hence relocation decisions must be cost effective or else this will defeat the purpose, straining organizational viability.

Separation Costs: Relocation also induces separation. There may be other reasons for separation, which may be either for organizational initiative or for individual employees’ reasons. Since separation requires replacement, immediate cost effect is on loss of production. Other costs of separation are redundancy benefits (if separation is organization induced), ex-gratia payments (if any), etc. Since separation follows immediate liquidation of fringe benefits, savings of the organization on this course also need to be considered to compute the actual costs.

Personal Overhead Costs: Personnel overhead costs spread over personnel record keeping, costs for maintaining Human Resources Information Systems (HRIS), cost of personnel decisions and overall costs for maintaining personnel department (salary of the people working in this department). Outsourcing personnel services to a great extent can reduce such cost burden. However, its relative merits and demerits need to be studied.

Support Costs: Some of the employee support services are statutory, while others are offered voluntarily by the organizations. For computing support costs, therefore, it is necessary to distribute these under two different heads and then study their impact. Medical welfare, canteens, safety, security, insurance (medi-claim, etc.), death benefits, parking space costs, etc. are some of the statutory costs for employee support services. While house journal, club membership, music at workplace, long service awards, suggestion schemes, library services, holiday homes, etc., are examples of voluntary support services for employees. Since, employee support services have direct effect on employee motivation, cost curtailment decisions must have reference to this aspect.

Management Notes

Historical development of Human Resource Accounting

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Human Resource Accounting (HRA) is the process of identifying, and reporting investments made in the human resources of an organization that are presently unaccounted for in the conventional accounting practice. It is an extension of standard accounting principles. Measuring the value of the human resources can assist organizations in accurately documenting their assets. In other words, human resource accounting is a process of measuring the cost incurred by the organisation to recruit, select, train, and develop human assets.

Recent years have witnessed the emergence of numerous trea-tises on the relative merits of human resource accounting. While the unprecedented pervasiveness of human resource literature suggests that the topic is new to our era, the debate itself is by no means novel. Indeed, the concept of human resource accounting is deeply rooted in the history of economic thought.

To provide a desirable perspective of the current debate and thus a basis for an accurate assessment of the probable impact of human resource accounting, a familiarity with the development of the concept is necessary. The intent of this article is to trace the historical evolution of human resource accounting to its present stage of development. Its purpose is to impart the perspective essential to a thorough understanding of the pros and cons of human resource accounting systems.

Human Capital in Early Economic Thought

Throughout history economists have been concerned with the concept of human capital, but their treatment was limited to including human beings and their skills in a definition of capital.

Several motives for treating human beings as capital and valuing them in monetary terms were expounded. Of these a central motive is apparent to serve as a basis for making a decision or to influence the decisions of others.

Meanwhile, a small group of relatively unknown economists un-dertook to develop techniques to measure the worth of human capital. Basically, two methods of estimating the value of human beings emerged:

  • The cost-of-production
  • The capitalized earnings procedures.

In the cost-of-production approach costs incurred in “producing” a human asset are estimated. The capitalized earnings procedure consists of estimating the present value of an individual’s future in-come stream. As described below, these two early approaches parallel closely the two basic approaches to human resource ac-counting currently advocated in the current literature.

Early Valuation Methods

Specific methods of human asset valuation, while consistent with one of the two general approaches, varied widely from one advocate to another. One of the first attempts to estimate the money value of human beings was made around 1691 by Sir William Petty. Petty considered labor the “father of wealth” and thus felt that labor must be included in any estimate of national wealth. Accordingly, this first attempt at human asset valuation estimated the value of the stock of human capital by capitalizing the wage bill in perpetuity at the market interest rate; the wage bill being determined by deducting property income from national income.

The first truly scientific procedure for finding the money value of human beings was devised in 1853 by Farr. He advocated the substitution of a property tax for the existing English income tax system. The former would include property consisting of the capitalized value of earning capacity. His procedure for estimating capitalized earning capacity was to calculate the present value of an individual’s net future earnings.

Ernst Engel’s writings around 1883 recommended a cost-of-pro-duction procedure for estimating the monetary value of human beings. He reasoned those expenditures for rearing children were costs to their parents and that this cost might be estimated and taken as a measure of their monetary value.

In 1867, a “composite” version reflecting Farr’s capitalized earn-ings and anticipating Engel’s cost-of-production approach surfaced when Wittstein argued that an individual’s lifetime earnings are equal to his lifetime maintenance cost plus education.

Alfred Marshall was perhaps the most forceful proponent of the concept of human assets. His theoretical approach took on a capitalized-net-earnings flavor. However, departing from his conceptual arguments, Marshall held that it would be out of touch with the marketplace to treat humans as capital in practical analysis,

Human Resources as Consumption Expenditures

Marshall’s view of human capital as being “unrealistic” was per-haps a major contribution to the virtual exclusion of the concept of human resources from the main stream of economic thought from the beginning of the twentieth century to the recent renewal of interest. Marshall’s view, if not a causal factor, is certainly descriptive of the general view that it was neither appropriate nor practical to apply the concept of capital to human beings.

Besides this accepted assessment, various other reasons prob-ably help explain the exclusion of humans from the concept of economic capital. Generally, the mere thought of investments in humans was offensive to most people. Additionally, it has been all too convenient in marginal productivity analysis for economists to treat labor as if it were a unique bundle of innate abilities that are wholly free of capital.

These reasons were probably sufficient to exclude human capital from the core of economic thought for several decades. Expenditures for humans were viewed as “consumption,” in economic jargon, rather than as “investments.” This treatment by economists had a significant impact upon the treatment accorded human resource expenditures by accountants.

Several of the underlying concepts of modern accounting theory are derived from classical economic theory and many of these matured during the period in which human capital was excluded from practical consideration by economists. Because of the close conceptual relationship between early accounting and economics, accounting theorists ignored human assets as the concept was simultaneously ignored in economic analysis. When economists began to treat investments in human resources as “consumption” rather than “investments,” accountants established that these expenditures were “expense” rather than “assets.”

Renewed Interest in Labor Intensive-Specialized Economy

The advent of massive governmentally supported social programs in the decade of the 1960’s rekindled the interest of economists in human assets. Particularly, economists sought to influence the direction of the massive investment in these social programs. They sought to evaluate these programs in terms of return on investment. This desire led to the necessity of thinking of such expenditures as capital rather than consumption expenditures.

Increasingly massive investments by industry in human assets have been cited as compounding the impact of the error of excluding human assets from capital. The large increases in real earnings of workers, essentially unexplained by classical analysis, can reasonably be attributed to return on investment in humans,

Moreover, Mincer has demonstrated the causal relationship between amount of training and interoccupational differentials in personal income.

The contribution of labor toward the growth rate of real national income is increasing as a percentage while the percentage contrib-uted by physical capital is decreasing. Labor’s increasing marginal product can be attributed in part to expenditures for training. Re-search by Thurow directed attention toward the existence of human capital resulting from investments in training programs.

The revival of interest by economists in the topic of human capital was accompanied by, or perhaps caused, an examination of the concept of human resource accounting by accounting theorists. Until then, accountants had considered the problem of valuing human resources to be part of the larger problem of valuing goodwill.

The recent research in this area attempts to distinguish economic values attributable to the human resources of a firm from the values attributable to other components of goodwill. These projects and limited implementation of research results is subsumed under the title of human resource accounting.

Research in human resource accounting reflects the two routes evidenced in contemporary accounting theory. One segment of the research is directed toward the investigation of concepts for the measurement of human resource costs: original cost, replacement cost, and opportunity cost. Another segment investigates the determinants of the value of human resources of employees as a group or of individual employees. This branching of current research in human resource accounting closely parallels the “cost of production” and “capitalized earnings” measurement approaches taken by early economists many decades ago.

Attempts to measure human resource cost have resulted in the development of three different concepts and measurement models. The first of these measurement concepts, original cost, is illustrated in the works of Brummet, Flamholtz, and Pyle who individually and collectively have developed concepts, models, and techniques for measuring the historical cost of human resources. Concern has been expressed over the historical cost concept namely, that the real economic value of the investment may be significantly different than its cost

The model of Brummet, et. al. is a generalized model which can be extended to incorporate replacement costs. Other researchers have developed models for the measurement of human resource replacement cost. The end result of the operation of such models is a measure of the cost to replace individuals occupying organizational position.

Perceived deficiencies in the replacement cost approach to measurements led others to develop the concept of opportunity cost to value human resources. Hekimian and Jones, for example, have suggested a system of competitive bidding to obtain managerial assessments of opportunity cost of human assets. Like the other measurement concepts, opportunity cost measurement has its critics as well.

Essentially, the suggestions to value human assets at historical or original cost are accounting adaptations of the “cost of production” techniques developed by Engels in 1883 and suggested by Shultz in 1960. Proposals to obtain replacement or opportunity cost measures parallel the current conceptual debate in accounting theory to find an acceptable alternate to historical cost.

While one segment of accounting research in human resource accounting has been directed toward measurement concepts, an-other is directed toward the investigation of the determinants of the value of human assets. The development of this theory is proceeding from two different approaches.

Growing out of the studies on organization and leadership at the University of Michigan’s Institute for Social Research, Likert and others have attempted to develop a model of determinants of a group’s value to an organization. Hermanson proposed two possible techniques for the monetary valuation of the total human assets of a firm. Additionally, Brummet, Flamholtz, and Pyle as well as Lev and Schwartz have suggested methods to arrive at the value of employees as a group. In a different approach, Flamholtz has attempted to develop a model of the determinants of an individual’s value to a firm.

With the exception of Likert’s model, the methods proposed for determining the value of employees or groups of employees to an organization are similar in principle to the proposal of the econo-mist William Farr. At the core of the proposals is the realization that the value of people to an organization is the present worth of the future services they are expected to render the “capitalized earnings” approach.

Likert’s model per se is not intended to measure the value of human resources, but the efficiency of various types of management systems. Likert, Flamholtz, Pyle, and Brummet have suggested that measurement of the present state of the causal and intervening variables would provide a basis to forecast future end-result variables. The forecasted end-result variables would serve as a basis to forecast future contributions by employees. This would serve as a basis to value human resources.

Hermanson’s suggested methods attempt to provide protection against manipulation by management. The proposals utilize capitalized current excess earnings or modified future employee earnings as a measure of human capital. In both proposals the impact of the economic concept of value is apparent.

The proposal of Lev and Schwartz to capitalize future compensation is an adaptation directly comparable to that of William Farr. Flamholtz’s suggestion for the valuation of an individual utilizes a series of capitalizations corresponding to the service states the individual is expected to occupy.

Management Notes

Methods of Human Resource Accounting

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It involves measuring the data of human resources, the cost involved in recruiting and maintaining them, and the returns achieved from them.

The more specific objectives of human resource accounting are as follows:

  1. To provide information for effectiveness of human resource utilization.
  2. To provide information for determining the status of human asset whether it is conserved properly; it is appreciating or depleting.
  3. To provide cost value date for managerial decisions regarding acquiring, developing, allocating and maintaining human resource so as to attain cost effective organizational objectives.
  4. To assist in the development of effective human resource Management practices by classifying the financial consequences of these practices.

Historical Cost:

Historical cost is based on actual cost incurred on human resources. Such a cost may be of two types ; acquisition cost and learning cost. Acquisition cost is the expense incurred on training and development. This method is very simple in its application but it does not reflect the true value of human assets. For example, an experienced employee may not require much training and, therefore, his value may appear to below though his real value is much more than what is suggested by historical cost method.

Replacement Cost:

As against historical cost method which takes into account the actual cost incurred on employees, replacement cost takes into account the national cost that may be required to acquire a new employee to replace the present one.

In calculating the replacement cost, different types of expenses are taken into account which may be in the form of acquisition and learning cost. Replacement cost is generally much higher than the historical cost.

For example, Friedman has estimated that the replacement cost of an executive in middle management level is about 1.5 to 2 times the current salary paid in that position. Replacement cost is much better indicator of value of human assets though it may present certain operational problems. For example, true replacement of a person may not be found easily with whose cost the valuation is done.

Standard Cost:

Instead of using historical or replacement cost, many companies use standard cost for the valuation of human assets just as its used for physical and financial assets. For using standard cost, employees of an organization are categorized into different groups based on their hierarchical positions.

Standard cost is fixed for each category of employees and their value is calculated. This method is simple but does not take into account differences in employees put in the same group. In many cases, these differences may be quite vital.

Present value of future earnings:

In this method, the future earnings of various groups of employees are estimated up to the age of their retirement and are discounted at a predetermined rate to obtain the present value of such earnings. This method is similar to the present value of future earnings used in the case of financial assets. However, this method does not give correct value of human assets as it does not measure their contributions to achieving organizational effectiveness.

Acquisition Cost Method:

Under this method the costs of acquisition, namely, the costs incurred in recruitment. Hiring and induction of employees are taken into account. The process involves capitalization of historic costs. The cost so capitalized has to be written off over a period of time for which the employee remains with the firm.

If for some reason the employee leaves the organization prematurely, the unamortized cost remaining in the books has to be written off against the profit and loss account of the particular year.

Replacement Cost Method:

While in the case of acquisition cost past costs are considered, under this approach one takes in to account how much it costs to replace a firm’s existing resources and thus represents a current value approach. So, this is a method resource and thus represents a current market conditions. This exercise may be redundant unless the management desires to replace its present resources. It is also difficult exercise as in many cases the replacement may not be exactly similar.

Present Value of Future Earnings Method:

This model is developed by Lev and Schwartz and is popular in India. This is also known as capitalization of salary method. Under this method the future earnings of an employee or grades of employees are estimated up to the age of retirement and are discounted at a rate appropriate to the person or the group in order to obtain the present value.

The model may be expresses as follows:

V = The human capital value of a person y years old

I (t) = The person’s annual earnings up to retirement

R = discount rate specific to the person

T= retirement age.

The above formula does not take into account the probability of a person dying before retirement or leaving the organization.

Expected realizable value:

The above methods discussed so far are based on cost consideration. Therefore these methods may provide information for record purpose but do not reflect the true value of human assets. As against these methods.

Expected realizable value is based on the assumption. And this is true also. That there is no direct relationship between cost incurred on an individual and his value to organization can be defined as the present worth of the set of future services that he is expected to provide during the period he remains in the organization.

Flamholtz has given the variables affecting an individual’s expected realizable value (IERV):

Individual conditional values and his like hood of remaining in the organization. The former is a function of the individual’s abilities and activation level. While the later is a function of such variables as job satisfaction, commitment, motivation, and other factors.

Economic Value Method:

The economist’s concept of the value of an asset is equal to the present worth of its estimated future economic benefits. This approach has a strong theoretical appeal.

But this method involves the following steps:

(a) Estimation of the future benefits, and

(b) Ascertaining the present value of such benefits by using an appropriate interest (discount) rate.

Competitive Bidding Method:

This is also known as the opportunity cost method. Opportunity cost is defined as the measurable value of benefits that could be obtained by choosing an alternative course of action. In the case of HRA. Opportunity costs are determined by a process of competitive bidding in which various divisions and departments bid for the services of various officers. The amount of bid is added to the capital employed of the successful bidder for determining the return on investment.

Management Notes

Amalgamation, Meaning, Reasons, Types, Advantages, Disadvantages

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Amalgamation refers to the process where two or more companies combine to form a single new entity or where one company absorbs another. It is undertaken to achieve various objectives such as expansion, increased market share, synergies, and economies of scale. In amalgamation, the assets and liabilities of the transferor company (or companies) are taken over by the transferee company. The shareholders of the transferor company are usually compensated through shares or other securities of the transferee company. Amalgamation can be in the nature of a merger or a purchase, depending on whether the companies continue their business as a going concern or not. It is regulated by legal frameworks such as the Companies Act and relevant accounting standards.

Reasons of Amalgamation:

  • Economies of Scale

Amalgamation enables companies to achieve economies of scale by combining their resources, infrastructure, and operations. The larger volume of production often leads to reduced per-unit costs in manufacturing, marketing, and administration. Shared facilities and workforce help in reducing duplication of efforts and expenses. Bulk purchasing of raw materials and centralized operations also bring down procurement and operational costs. This makes the amalgamated entity more cost-efficient and competitive in the market. Additionally, the optimization of resources leads to better utilization of capacity and a stronger financial position, helping the company operate more profitably in the long term.

  • Business Expansion

Amalgamation allows companies to expand their operations geographically and functionally. By joining forces, companies can enter new markets or strengthen their presence in existing ones without starting from scratch. This expansion can cover products, services, distribution channels, or customer bases. The combined entity may also gain access to new technology, R&D capabilities, or skilled employees. Expansion through amalgamation is often faster and less risky than organic growth. It enables companies to diversify their portfolios and reduce dependence on a single segment, thereby increasing growth potential and enhancing their competitive edge in both domestic and international markets.

  • Elimination of Competition

Amalgamation can eliminate direct competition between companies operating in the same industry. When competitors merge, it leads to reduced price wars and market rivalry. This helps stabilize prices and improve profit margins. The combined entity often gains better control over market share and pricing power. By reducing competition, companies can focus more on innovation, customer satisfaction, and long-term strategic goals rather than short-term survival tactics. Additionally, amalgamation helps prevent hostile takeovers by competitors. It is a strategic move to consolidate market position, streamline operations, and strengthen bargaining power against suppliers, customers, and regulators.

  • Tax Benefits

Amalgamation can offer significant tax advantages under prevailing tax laws. Loss-making companies, when amalgamated with profit-making ones, allow the latter to set off the accumulated losses and unabsorbed depreciation of the former against their taxable income. This results in reduced tax liability for the amalgamated entity. Furthermore, certain amalgamations qualify for tax exemptions under specific provisions of the Income Tax Act, making the process financially beneficial. These tax benefits improve the post-merger profitability and cash flows of the new entity. Companies often consider amalgamation as a strategic tool to optimize their tax planning and enhance shareholder value.

  • Improved Managerial Efficiency

Amalgamation brings together the managerial talents and administrative strengths of the combining companies. The pooling of experienced and skilled professionals enhances decision-making, planning, and execution capabilities. It eliminates overlapping positions and departments, leading to a more streamlined and efficient organizational structure. The best practices of both companies can be adopted and implemented across the merged entity, improving productivity and innovation. Additionally, better leadership and governance may emerge from the amalgamation, strengthening corporate strategy and culture. Overall, managerial synergy results in enhanced organizational performance and supports the long-term success of the amalgamated business.

  • Diversification of Risk

Amalgamation facilitates risk diversification by enabling companies to operate in multiple sectors, markets, or product lines. When companies with different business models or market focuses combine, they reduce their dependence on a single income stream or market condition. This diversification helps stabilize revenue and protects the company from industry-specific downturns or economic fluctuations. For example, if one segment performs poorly, profits from other segments can balance the overall financial health. It also allows for better capital allocation and investment planning. In this way, amalgamation serves as a strategic move to minimize business risk and enhance sustainability.

  • Better Utilization of Resources

Through amalgamation, idle or underutilized resources such as plant, machinery, human capital, and financial assets can be better deployed. Combining operations often reveals overlapping capacities that can be optimized to increase efficiency. For instance, surplus cash from one company can be used to fund profitable projects in another. Similarly, excess workforce or production capacity can be redirected for maximum productivity. Better asset utilization leads to higher returns on investment and improved financial ratios. Moreover, amalgamation encourages effective internal restructuring, resource sharing, and cost control, ensuring that the new entity operates at an optimal performance level.

Types of Amalgamation:

  • Amalgamation in the Nature of Merger

Amalgamation in the nature of merger occurs when two or more companies combine to form a new entity, and all assets, liabilities, and shareholders’ interests are pooled together. This type of amalgamation is based on the principle of continuity of business and shareholders’ interest. There is no adjustment to the book values of assets and liabilities, and the business of the transferor company continues in the same manner under the transferee company. At least 90% of the equity shareholders of the transferor company become shareholders of the transferee company. Such amalgamations are treated as a unification of interests and follow the Pooling of Interests Method under Accounting Standard (AS) 14. It aims to create synergies and enhance overall business value.

  • Amalgamation in the Nature of Purchase

Amalgamation in the nature of purchase occurs when one company acquires another, and the transferor company is dissolved without forming a new entity. This is not a merger of equals but rather a business acquisition. In this case, the transferee company does not necessarily take over all assets and liabilities of the transferor company. Also, there is no requirement that the shareholders of the transferor company become shareholders of the transferee company. The consideration paid may be in the form of cash, shares, or other assets. This type of amalgamation is recorded using the Purchase Method under AS 14, where the assets and liabilities are recorded at their fair values, and the difference is treated as goodwill or capital reserve.

Advantages of Amalgamation:

  • Economies of Scale

Amalgamation allows companies to combine resources, leading to cost savings through bulk purchasing, shared infrastructure, and streamlined operations. Larger production scales reduce per-unit costs, improving profitability. Merged entities can negotiate better terms with suppliers and optimize distribution networks. Additionally, administrative expenses (like accounting, HR, and legal costs) are reduced when functions are consolidated. This efficiency makes the new entity more competitive in the market.

  • Enhanced Market Share & Competitive Strength

By merging, companies eliminate competition between themselves and gain a stronger market position. The combined entity can leverage a larger customer base, diversified products, and stronger brand recognition. This increased market power helps in negotiating better deals, resisting price wars, and expanding into new regions. Competitors find it harder to challenge a larger, more resourceful firm, ensuring long-term stability.

  • Diversification of Risk

Amalgamation helps spread business risks across different industries or markets. If one sector faces a downturn, losses can be offset by profits from other segments. This reduces dependency on a single revenue stream, ensuring financial stability. For example, a manufacturing firm merging with a logistics company can balance operational risks. Diversification also attracts investors seeking lower-risk portfolios.

  • Access to New Technologies and Expertise

A smaller firm merging with a technologically advanced partner gains immediate access to R&D, patents, and skilled personnel. This accelerates innovation without heavy upfront investment. The combined expertise improves product quality and operational efficiency. For instance, a traditional bank merging with a fintech firm can quickly adopt digital banking solutions, staying ahead of competitors.

  • Improved Financial Strength and Creditworthiness

After amalgamation, the combined balance sheet shows higher assets, revenues, and reserves, improving credit ratings. Banks and investors are more willing to lend at lower interest rates due to reduced risk. The merged entity can also raise capital more easily through equity or debt, funding expansions and modernization projects that were previously unaffordable.

  • Tax Benefits & Synergies

Governments often provide tax incentives for amalgamations, such as carry-forward losses or deferred tax liabilities. Operational synergies (like shared marketing or R&D) further reduce costs. The merged entity can optimize tax planning by offsetting profits of one unit against losses of another, leading to significant tax savings and improved cash flows.

Disadvantages of Amalgamation:

  • Loss of Identity

Amalgamation often leads to the loss of individual identity of one or more companies involved. The smaller or absorbed company may lose its brand name, culture, and goodwill built over years. Employees and customers who were loyal to the original entity may feel disconnected or dissatisfied with the merged entity. This loss can affect customer relationships, market perception, and internal morale. Additionally, stakeholders of the transferor company may feel alienated or undervalued post-amalgamation. Such identity dilution may impact brand loyalty and could reduce the competitive edge that the original company once held independently in its market segment.

  • Cultural Clashes

Different companies often have distinct corporate cultures, management styles, and operational philosophies. When they amalgamate, cultural differences may lead to internal conflicts, reduced morale, and lack of coordination among employees. Misalignment in work ethics, communication practices, and decision-making approaches can result in misunderstandings and inefficiencies. Employees may resist changes, leading to reduced productivity and engagement. Management may also struggle to integrate teams and establish a cohesive culture. If not handled properly, cultural clashes can impact the overall success of the amalgamation and result in a decline in employee satisfaction, talent retention, and organizational performance.

  • Redundancy and Layoffs

One major drawback of amalgamation is redundancy in job roles, departments, or resources. To reduce costs and improve efficiency, companies may lay off employees performing similar roles across merged entities. This can lead to widespread job insecurity, dissatisfaction, and unrest among the workforce. The psychological impact of layoffs can lower employee morale and productivity, even among retained staff. In some cases, valuable talent may be lost due to voluntary resignations. Moreover, labor unions and regulatory bodies may raise concerns over workforce reduction, leading to legal or reputational challenges for the new entity.

  • High Cost of Amalgamation

The process of amalgamation can be expensive and time-consuming. It involves legal, financial, and administrative costs such as due diligence, asset valuation, consultancy fees, regulatory approvals, and integration planning. The actual execution of amalgamation—merging operations, aligning systems, and training staff—may demand significant financial resources. If the anticipated synergies are not realized, these upfront costs can outweigh the benefits. Also, unexpected liabilities of the transferor company may surface post-merger, adding to financial burdens. Therefore, improper planning and execution can result in financial strain and poor return on investment for the amalgamated entity.

  • Management Disputes

Amalgamation often results in the restructuring of management, which can lead to power struggles, ego clashes, or differences in strategic vision between executives of the merging companies. Lack of clarity in leadership roles and responsibilities may create confusion and reduce efficiency. Competing interests among senior management can slow down decision-making and negatively impact employee confidence in leadership. If not managed carefully, such disputes can erode trust, derail integration efforts, and cause long-term instability in the organization. Ultimately, poor management alignment after amalgamation may weaken the strategic direction and performance of the new entity.

Management Notes

Advances, Characteristics, Types

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Advances refer to short-term financial assistance provided by banks and financial institutions to businesses, individuals, or organizations to meet their working capital needs. Unlike loans, advances are typically repayable within a year and are granted based on creditworthiness, security, or future receivables. Common types include overdrafts, cash credit, and bill discounting. Advances help in managing liquidity, short-term operational costs, and urgent financial requirements. They usually attract lower interest rates than long-term loans and provide flexibility in fund utilization. Banks assess factors like financial stability, past transactions, and collateral before granting advances to minimize risks and ensure repayment.

Characteristics of Advances:

  • Short-Term Nature

Advances are primarily short-term financial instruments provided by banks to meet immediate financial needs. Unlike loans, which have long repayment periods, advances are usually repayable within a year. Businesses use advances for working capital management, payroll, and inventory purchases. The tenure is decided based on the borrower’s financial standing and the type of advance. Since advances are for short durations, they have lower interest rates compared to long-term loans, making them a cost-effective financing solution for urgent financial requirements.

  • Security-Based or Unsecured

Advances can be secured or unsecured depending on the borrower’s creditworthiness and the bank’s lending policy. Secured advances require collateral, such as stocks, fixed deposits, or receivables, which banks can liquidate if the borrower defaults. Unsecured advances are granted based on a strong credit history, good repayment record, and financial stability. While secured advances have lower interest rates, unsecured advances attract higher interest rates due to the increased risk. The approval process for unsecured advances is more stringent due to the lack of security.

  • Interest on Utilized Amount

Unlike traditional loans where interest is charged on the entire loan amount, advances often charge interest only on the utilized portion. For example, in cash credit and overdraft facilities, a business may have a sanctioned limit but pays interest only on the withdrawn amount. This feature helps businesses manage liquidity efficiently without incurring unnecessary interest costs. The interest rates vary based on the type of advance, security offered, and the bank’s policies. This makes advances a flexible and cost-effective financing option.

  • Quick Processing and Disbursement

Advances are designed to meet urgent financial needs, so banks process them faster than loans. The approval and disbursement process is less time-consuming, especially for existing account holders with a good banking relationship. Businesses often need immediate funds for raw material purchases, salaries, or unexpected expenses, and banks ensure minimal delays. The quick processing of advances helps companies avoid financial disruptions and continue their operations smoothly. However, unsecured advances may take longer due to the risk assessment and credit verification process.

  • Flexible Repayment Terms

Advances offer flexible repayment schedules, unlike fixed-term loans. Borrowers can repay partially or fully based on their cash flow and financial position. Facilities like overdrafts and cash credit accounts allow borrowers to repay and withdraw multiple times within the sanctioned limit. This flexibility helps businesses manage their working capital efficiently without facing strict repayment deadlines. However, banks may impose penalties for delayed repayments, and failure to repay secured advances can result in the liquidation of pledged collateral.

  • Purpose-Oriented Financing

Advances are usually granted for specific short-term purposes, such as working capital, trade finance, or operational expenses. Unlike long-term loans, which fund capital investments, advances cater to immediate liquidity needs. Businesses commonly use advances for inventory purchases, supplier payments, or seasonal expenses. Since advances are purpose-driven, banks closely monitor their utilization. Misuse of funds can lead to cancellation of the advance facility or higher interest rates. The purpose-oriented nature of advances ensures that borrowers use funds effectively for business operations.

  • Renewal and Review Policy

Most advances are subject to annual renewal and periodic review by the bank. The borrower’s financial health, repayment history, and market conditions are assessed before renewal. If the borrower has a strong repayment record, the bank may increase the credit limit or offer better terms. However, poor repayment behavior can result in higher interest rates, reduced limits, or cancellation of the facility. Regular reviews ensure that banks manage risks effectively and that advances are being utilized for productive financial purposes.

Types of Advances:

  • Cash Credit (CC)

Cash Credit is a short-term borrowing facility provided to businesses against collateral such as stock, receivables, or fixed deposits. Banks sanction a credit limit, and the borrower can withdraw funds as needed, paying interest only on the utilized amount. This facility is useful for businesses to meet working capital requirements. The sanctioned limit is reviewed periodically, and the borrower must maintain the agreed security margin. If the borrower fails to repay, the bank can seize the collateral. Cash Credit is widely used by businesses for continuous financial support without taking multiple loans.

  • Overdraft (OD)

An Overdraft is a facility where banks allow customers to withdraw more than their account balance, up to a specified limit. It is linked to a current account, and the customer pays interest only on the amount used. The overdraft can be secured or unsecured, depending on the borrower’s creditworthiness and relationship with the bank. It is primarily used by businesses and individuals for short-term liquidity management. The limit is renewed periodically, and banks may demand repayment if the overdraft is misused. This facility helps businesses manage cash flow fluctuations efficiently.

  • Bills Discounting

Bill Discounting is a type of advance where banks provide immediate funds against bills of exchange or trade receivables before their maturity. It helps businesses convert their sales into instant cash rather than waiting for payment from buyers. The bank deducts a discounting charge (interest) upfront and credits the remaining amount to the borrower’s account. If the buyer defaults, the borrower is responsible for repayment. This facility is crucial for businesses engaged in trade, ensuring continuous cash flow and reducing credit risk.

  • Loan Against Fixed Deposit (FD)

Banks offer advances against fixed deposits, allowing customers to borrow funds up to a certain percentage (usually 80-90%) of their FD amount. The interest rate on such advances is lower than regular loans since the FD serves as collateral. The borrower continues to earn interest on the FD while using the borrowed funds. This facility is useful for emergency needs as it allows customers to access liquidity without breaking their FD. If the borrower defaults, the bank can adjust the loan amount from the FD maturity proceeds.

  • Letter of Credit (LC) Advances

Letter of Credit (LC) is a banking instrument that assures payment to a seller on behalf of a buyer, provided the specified conditions are met. Banks offer advances against LC by discounting it or financing the buyer to make payments. This facility is widely used in international trade to reduce credit risk and ensure smooth transactions. If the buyer defaults, the issuing bank steps in to pay the seller, securing repayment from the buyer later. LC advances help businesses maintain trade credibility and manage short-term financing efficiently.

  • Packing Credit

Packing Credit is a pre-shipment finance facility provided to exporters to meet the cost of raw materials, labor, and production before shipment. It ensures that exporters have sufficient working capital to manufacture and process goods for export. The repayment is made when the export proceeds are realized. Packing Credit is often provided at preferential interest rates, backed by export bills, confirmed orders, or LC. This facility helps businesses fulfill export commitments without financial constraints. If the exporter fails to complete the order, banks may demand repayment or seize collateral.

  • Term Loan Advances

Term Loans are longer-duration advances provided for specific purposes, such as business expansion, equipment purchase, or infrastructure development. These advances are repaid in installments over a fixed tenure and can be secured or unsecured. The interest rate depends on the borrower’s credit profile, business viability, and collateral offered. Term loans help businesses finance capital expenditures and ensure steady business growth. Failure to repay may result in legal action or asset seizure by the bank. Unlike cash credit or overdrafts, term loans do not allow flexible withdrawals.

  • Agricultural Advances

Agricultural advances are specialized loans provided to farmers for crop production, irrigation, farm machinery, and other agricultural needs. These advances are often subsidized by the government and come with lower interest rates and flexible repayment schedules. Banks assess factors such as landholding, past agricultural productivity, and seasonal requirements before granting the advance. If farmers face crop failure due to natural disasters, banks may offer loan restructuring or moratoriums. This type of advance supports rural economic development and ensures financial stability for the agricultural sector.

  • Personal Advances

Personal advances are short-term credit facilities offered to individuals for personal expenses such as education, medical emergencies, weddings, or travel. These can be secured or unsecured, depending on the amount and borrower’s creditworthiness. The repayment tenure is usually short, and interest rates vary based on risk assessment and borrower profile. Since these advances cater to urgent needs, they are quickly processed but may have higher interest rates. Banks assess the individual’s income, employment stability, and repayment capacity before approving personal advances.

  • Bridge Loan Advances

Bridge Loans are short-term advances used to finance temporary cash shortfalls before securing a permanent loan or long-term funding. These advances are common in real estate and business takeovers, where immediate capital is required to complete a transaction. The repayment period is typically six months to two years, and interest rates are higher due to the short tenure and high risk. Borrowers must repay the bridge loan once long-term financing is secured. These advances help businesses seize opportunities without waiting for traditional loan approvals.

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