Return of investment in HRP Meaning and importance

According to Sikula “the ultimate purpose/objective of human resource planning is to relate future human resources to future enterprise need so as to maximise the future return on investment in human resources”.

Human resources are 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.

“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.

Formula to Calculate Human Capital ROI

The formula to calculate the Human Capital ROI is very simple. Human Capital RIO is the Revenue minus non-human capital expenses divided by Human Capital Expenses.

Non-Human Capital Expenses = Operating Expenses – Human Capital Expenses

Human Capital Expenses = Fixed compensation(salaries) + Variable compensation + Benefits + Indirect cost

Revenue = The adjusted revenue after deducting the cost of capital, depreciation, etc

Importance of Calculating Human Capital ROI

Human Capital ROI helps to analyze which factors help or hinder the profitability and productivity of the organization. It can be either organizational and personal factors.

Furthermore, It also enables the organization to create or provide the right atmosphere to its employees. This will eventually result in relatively fast and more productivity.

MNCs measures HCROI on a short-term and long-term basis. This helps them to find which external or internal factors influence the productivity of their workforce.

It helps to know whether the right candidates have been hired or retained. It further helps to know whether or not the proper level of training and skills are developed in employees.

In addition to the above, it enables the organization to know that the environment provided for employees to flourish is right or not.

It will identify whether right leadership and managerial support are available to the employees. This enables them to accomplish and align with the company’s business objectives.

Knowledge of all the above things helps us implement proper initiatives that help us to improve the ROI.