For finance and accounting executives, calculating return on investment (ROI) is an all too familiar task. From tangible items such as office space, supplies and equipment, to less-tangible considerations such as labor, leadership training and even employee engagement, ROI plays an important role in determining the value of organizational investments.
While traditionally these calculations have been limited to tangible investments, a recent rise in the cost of human capital has many chief financial officers (CFOs) pushing for calculating of ROI in more intangible investments, in particular human capital.
“The reality is that the cost of people in an organization is often almost always the largest individual expense,” said Jack Phillips, Ph.D., chairman of the ROI Institute and author of more than 50 books including Show Me the Money: How to Determine ROI in People, Projects, and Programs and Investing in Your Company's Human Capital: Strategies to Avoid Spending Too Little -- or Too Much. “In addition, new projects and programs in this area are very expensive and leadership needs to know the investment in items such as leadership development before the money is spent.”
This requires carefully assessing the ROI of human capital and determining the return they are receiving from full-time employees and contract workers, as well as investments made in employee programs such as leadership development and wellness initiatives.
According to Phillips, the best way to examine the ROI of human capital investments is to approach them as if they were capital investments.
“If you look at the information that is out there, a number of organizations look at the term ROI to mean benefit, and this is misleading,” said Phillips. “Instead, organizations should examine the ROI of non-capital investments just as finance and accounting would examine any other investment, by calculating earnings over investment. Divide, then multiply by 100 and you have the ROI percentage.”
Phillips notes that, while there are many ways of calculating return, including return on people (ROP) and return on expectation (ROE), it is risky to stray away from the classic ROI calculation as this is the number recognized by finance and accounting executives.
However, investments should never be vetted solely on their ROI percentage.
“It is important to never use this number alone in your decisions to purchase a capital or non-capital expense,” said Phillips. “To that end, the ROI Institute suggests six data types be examined within the ROI methodology, with the actual ROI calculation being only one of them.”
The six types of data are:
- Reaction, satisfaction and planned action
- Learning and application
- Business Impact
Based on these six data types, organizations will be able to examine investments with a balanced profile of success.
“The ROI is often a very emotional number,” said Phillips. “If it is too high, we don’t believe it and if it is too low we want to kill the project. Organizations need to control these emotions, and that is what these data points do.”
Human Capital Investments
Based on these calculations, finance and accounting executives can examine human capital investments and determine which ones make the most sense for their organization. This is particularly important when looking to hire contract or temporary employees.
“When looking to hire, it is important to use the ROI analysis to determine whether a temporary employee makes sense for the organization,” said Phillips. “Examine what it will cost to hire a permanent employee versus what it will cost to hire a temporary employee. Many times it comes out to be a very positive ROI to hire someone temporarily.”
This ROI should be examined for every aspect of the human capital selection, from recruiting and onboarding to training and development, and even wellness and fitness programs, as organizations will be investing in each of these areas.
“What is the payoff in these areas? And what is the ROI? These are the items you should be looking at,” said Phillips.
This ROI should also be examined from entry to exit point, as much of the reluctance to hire permanent employees comes from the impact of having to let them go. Further, organizations should examine the stability of the organization when looking to hire.
“If you have a lot of growth and certainty, then certainly look to hire a permanent employee,” said Phillips. “However, if you see peaks or valleys of demand for employees in the future, you will not want to hire permanently.”
To increase the ROI from both temporary and permanent employees, Phillips recommends utilizing a recruiting source with the resources necessary to find the best employee for the position. Doing so will result in employees who perform better and stay with the organization longer, thus increasing success and ROI.
Finally, organizations should examine the ROI from people, projects and programs on a continual basis.
“Organizations should be looking at their investments in their staff and the programs for their staff on a continual basis,” said Phillips. “Doing so is a key tool for the human resource team these days and organizations will be woefully inadequate if they chose to forego these analyses.”
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