Identifying and measuring the value of human capital can be a process worth investing.
The concept of value has essentially two different meanings. 'Value' expresses the utility or service of a particular resource (e.g. the future use of a capital asset) and the purchasing power of the resource (e.g. money, securities). If an object is not capable of rendering future economic services in the form of utility to the possessor, no value can be attached to it.
Employees are the most valuable resources of comparison in the service (software, banking, management consultancy, etc.) sector. Like all other resources of the company, the employees possess value because of providing future services.
"Human Resource Valuation means identifying and measuring value of human resources and communicating the information to the interested parties."
Why value our value ?
The need to meet the increasing business opportunities of future, and simultaneously maintain or improve upon the current level of performance, has made organisations to look consciously into the manpower as the future leverage for success. Coupled with the above mentioned situation, adopting a 'prudent and comprehensive disclosure policy' has become the key differentiating agent among players in the same industry.
These default factors has laid the foundation stone for the ongoing popularity of the Human Resource Valuation. In India HR valuation was first implemented by the public sector giants (e.g. BHEL, SAIL, etc.) For the last two years, HR value reporting has gained momentum amongst the software companies. These companies have valued their Human Resources which has been disclosed in their Annual Reports as a statement of intangibles (additional notes to the accounts). The benefits that result from HR valuation exercise are enumerated below :
A move towards investor friendly disclosure, to make them fully aware of the company's human assets. The investors can also assess the return on human capital, which is in essence the return they are getting from people who are managing their wealth / investment. For the foreign institutional investors, who are not fully aware of the day to day happenings of the company, HR value reporting is a decision making for investment in the company's equity.
An assurance to customers - the company has the human capital reserve to service their demand.
A feeling of comfort for the company's employees that they are assets and not expenses of the firm.
A future tool for better performance appraisal and manpower assessment. The management can also realise the present value of its future commitment of providing employee compensation.
HR value services as a benchmarking parameter with other value presenters of the industry.
Valuation methodologies
Before suggesting an approach to HR valuation, let us look into the various methods available for HR valuation :
Cost based approaches :
Historical cost method : This method was proposed by Brummet to measure a firm's investment in human resources. The human resource costs are current sacrifices for obtaining future benefits and therefore to be treated as assets. The method suggest to capitalise the firm's expenditure on recruitment, selection, training and development of employees and treat them as assets for the purpose of human resource accounting.
However, capitalisation of costs, besides being contrary to traditional accounting norms, does not reflect value. Also, accumulated costs of human resource acquisition and development may not reflect their value. Instead, total performance needs to be judged in relation to the total cost associated with HR to reflect their value.
Replacement cost method : This method involves assessment of replacement cost of individuals, and rebuilding cost of the organisation to reflect HR asset value of both the individuals and the organisation. However, the replacement cost may not reflect either the actual costs or the contribution associated with HR.
Opportunity cost method : This model envisages computation of monetary value and allocation of people to the most promising activity and thereby to assess the opportunity cost of key employees through competitive bidding among investment centres.
As an example, let us suppose that oracle applications development business unit's target ROI is 16% and it has a capital base of Rs.1,00,00,000 but its profit is only Rs.13,00,000 which is Rs.3,00,000 short of the target. It is felt by the unit that if it can acquire the services of a particular executive, its profit improves by Rs.4,00,000. The profits will be Rs.17,00,000, i.e., Rs.100,000 more than Rs.16,00,000 (the target ROI). Rs.100,000 capitalised at 16% comes to Rs.6,25,000 and the unit can bid upto Rs.6,25,000 for the services of the executive.
Behavioural model : This model aims to establish a set of casual variables through psycho-social test results reflecting the appreciating or depreciating condition of human organisation as reflected by a set of intervening variables, which in turn, are likely to result in the achievement of the end result variables. The investments in HR value have been proposed to be amortised over the years in tune with the condition of the human organisation. However, psycho-social measures of the condition of the human organisation may not be reliable towards measure of HR as an asset in the absence of its established valid relationships with the organisational performance.
Economic model : Lev & Schwartz advocated the estimation of future earnings during the remaining life of the employee and then arriving at the present value by discounting the estimated earnings at the employee's cost of capital. The formula adopted for computation of the present value of the future earnings is An extension to the above formula propounded by Lev & Schwartz is that one can consider the probability of the person dying before the retirement age.
Flamholtz proposed HR value on parlance with the roles the employees perform which is in accordance with the service state they occupy. The model also considers the present value of the future services at different service states and takes into consideration the migration of an employee from one service state to the other. However, the estimates of the employees occupying different service states in his/her career in the organisation can be highly probabilistic and unreliable.
Harmonson advocated the HR value as the present value of the future wages payable for the next five years discounted at the adjusted rate of return. The adjusted rate of return is the average rate of return on the owned assets of all firm in the economy multiplied by efficiency ratio of the organisation. This method attempts to bring into question the effectiveness of ROI of the industry on the assumption that there are no extraneous factors and that the results were due to efforts of the employees.
However, the model is very subjective as it considers the present value of the future wages only for the next five years, efficiency ratio based on the rate of return of the last five years and the assignment of weights to past rate of return.
Each model has its own negatives and positives when it comes to practical application. In an Indian context, the Lev & Schwartz model has an edge over the other models. Since the method has been widely adopted by Indian companies such as Infosys, DSQ Software Ltd., Satyam Computers, BHEL and SPIC, it enables the company to benchmark the performance and the efficiency of their human resources with others. The assumptions in this model are realistic and scientific. The method has practical applicability when availability of quantifiable and analysable data is concerned.
Suggested methodology
We may adopt the basic premises of Lev & Schwartz model for valuing their human resources of a company after parallely ascertaining a human organisational inventory (HOS) to assess the effect of qualitative human variables (e.g., employee job satisfaction, 360 degree peer evaluation, etc.) on HR value.
In a nutshell, the approach involves valuing the employees of the organisation by projecting the current direct and indirect benefits (cost to company - CTCs) enjoying by the employees (a future cash outflow to the company) till retirement and consequently discounting the CTCs at the Weighted Average Cost of Capital of the firm (WACC) to arrive at the present value which is to be furnished in Annual Report. The WACC is calculated taking into consideration the target debt equity proportion, weighted average cost of debt, and cost of equity adjusted with company specific beta value, volume of trading and equity premiums. The optimum HR strategy for the future can be formulated by combining groupwise HR value, the findings from the HR inventory, and analysing the efficiency of the recruitment and training cost centres of the company..
Some basic assumptions for HR valuation
Each employee's cost to company (CTC) should be forecasted and discounted back separately. Thus a separate database comprising compensation details, age and experience details, historical promotion pattern for each employee should be constructed. The database serves as a powerful MIS tool for value interpretation.
The growth rate of earnings of each employee till retirement should be determined for projecting the CTCs after looking into the company's compounded annual growth in CTC's for different employee classes, global industry trends for the future (e.g., what happens after 5 years when the demand for Y2K jobs in the software sector obliterates), and sustainable growth rates for the next 25-30 years given the nominal interest rates of the Indian economy.
The attrition rates for the company / industry should not be considered as a deduction factor, as the employees who leave the company will be replaced by others to maintain the level of operations, and thereby the employee strength remains unchanged (conservation of employee stock / inventory). This is also consistent with the going concern concept.
Underlying meaning of HR value
The HR value per se throws valuable insights into the HR strategy of the firm. On one hand, it is a value of the employees of the company - thinking differently managements should realise that HR value is the future commitment which the firm has to pay to its employees for the career span in the company.
Thus, a high or low HR value will have to be justified with the returns it can achieve. Hence the return on HR value (ROHA) should be the efficiency measure of human resources on a year to year basis. The ROHA factor will assist management to manage the value / commitment better in future years. The HR turnover ratio can also be taken as an indicator of efficiency.
Companies can also make a conscious move to capture its costs related to HR department by developing a human resource accounting system which compliments the HR valuation exercise. The system can provide a cost clarity in all relevant areas related to the human resources of the company. In future, managements should begin to use HR value in regular MIS reports, in areas such as measurement of SBU profitability, SBU performance trend analysis, etc. which can fine-tune the appraisal system.
//Samrat Gupta is MIS Manager at DSQ Software Ltd., Chennai. An MBA from Manchester Business School.//
From India, Gurgaon
660The concept of value has essentially two different meanings. 'Value' expresses the utility or service of a particular resource (e.g. the future use of a capital asset) and the purchasing power of the resource (e.g. money, securities). If an object is not capable of rendering future economic services in the form of utility to the possessor, no value can be attached to it.
Employees are the most valuable resources of comparison in the service (software, banking, management consultancy, etc.) sector. Like all other resources of the company, the employees possess value because of providing future services.
"Human Resource Valuation means identifying and measuring value of human resources and communicating the information to the interested parties."
Why value our value ?
The need to meet the increasing business opportunities of future, and simultaneously maintain or improve upon the current level of performance, has made organisations to look consciously into the manpower as the future leverage for success. Coupled with the above mentioned situation, adopting a 'prudent and comprehensive disclosure policy' has become the key differentiating agent among players in the same industry.
These default factors has laid the foundation stone for the ongoing popularity of the Human Resource Valuation. In India HR valuation was first implemented by the public sector giants (e.g. BHEL, SAIL, etc.) For the last two years, HR value reporting has gained momentum amongst the software companies. These companies have valued their Human Resources which has been disclosed in their Annual Reports as a statement of intangibles (additional notes to the accounts). The benefits that result from HR valuation exercise are enumerated below :
A move towards investor friendly disclosure, to make them fully aware of the company's human assets. The investors can also assess the return on human capital, which is in essence the return they are getting from people who are managing their wealth / investment. For the foreign institutional investors, who are not fully aware of the day to day happenings of the company, HR value reporting is a decision making for investment in the company's equity.
An assurance to customers - the company has the human capital reserve to service their demand.
A feeling of comfort for the company's employees that they are assets and not expenses of the firm.
A future tool for better performance appraisal and manpower assessment. The management can also realise the present value of its future commitment of providing employee compensation.
HR value services as a benchmarking parameter with other value presenters of the industry.
Valuation methodologies
Before suggesting an approach to HR valuation, let us look into the various methods available for HR valuation :
Cost based approaches :
Historical cost method : This method was proposed by Brummet to measure a firm's investment in human resources. The human resource costs are current sacrifices for obtaining future benefits and therefore to be treated as assets. The method suggest to capitalise the firm's expenditure on recruitment, selection, training and development of employees and treat them as assets for the purpose of human resource accounting.
However, capitalisation of costs, besides being contrary to traditional accounting norms, does not reflect value. Also, accumulated costs of human resource acquisition and development may not reflect their value. Instead, total performance needs to be judged in relation to the total cost associated with HR to reflect their value.
Replacement cost method : This method involves assessment of replacement cost of individuals, and rebuilding cost of the organisation to reflect HR asset value of both the individuals and the organisation. However, the replacement cost may not reflect either the actual costs or the contribution associated with HR.
Opportunity cost method : This model envisages computation of monetary value and allocation of people to the most promising activity and thereby to assess the opportunity cost of key employees through competitive bidding among investment centres.
As an example, let us suppose that oracle applications development business unit's target ROI is 16% and it has a capital base of Rs.1,00,00,000 but its profit is only Rs.13,00,000 which is Rs.3,00,000 short of the target. It is felt by the unit that if it can acquire the services of a particular executive, its profit improves by Rs.4,00,000. The profits will be Rs.17,00,000, i.e., Rs.100,000 more than Rs.16,00,000 (the target ROI). Rs.100,000 capitalised at 16% comes to Rs.6,25,000 and the unit can bid upto Rs.6,25,000 for the services of the executive.
Behavioural model : This model aims to establish a set of casual variables through psycho-social test results reflecting the appreciating or depreciating condition of human organisation as reflected by a set of intervening variables, which in turn, are likely to result in the achievement of the end result variables. The investments in HR value have been proposed to be amortised over the years in tune with the condition of the human organisation. However, psycho-social measures of the condition of the human organisation may not be reliable towards measure of HR as an asset in the absence of its established valid relationships with the organisational performance.
Economic model : Lev & Schwartz advocated the estimation of future earnings during the remaining life of the employee and then arriving at the present value by discounting the estimated earnings at the employee's cost of capital. The formula adopted for computation of the present value of the future earnings is An extension to the above formula propounded by Lev & Schwartz is that one can consider the probability of the person dying before the retirement age.
Flamholtz proposed HR value on parlance with the roles the employees perform which is in accordance with the service state they occupy. The model also considers the present value of the future services at different service states and takes into consideration the migration of an employee from one service state to the other. However, the estimates of the employees occupying different service states in his/her career in the organisation can be highly probabilistic and unreliable.
Harmonson advocated the HR value as the present value of the future wages payable for the next five years discounted at the adjusted rate of return. The adjusted rate of return is the average rate of return on the owned assets of all firm in the economy multiplied by efficiency ratio of the organisation. This method attempts to bring into question the effectiveness of ROI of the industry on the assumption that there are no extraneous factors and that the results were due to efforts of the employees.
However, the model is very subjective as it considers the present value of the future wages only for the next five years, efficiency ratio based on the rate of return of the last five years and the assignment of weights to past rate of return.
Each model has its own negatives and positives when it comes to practical application. In an Indian context, the Lev & Schwartz model has an edge over the other models. Since the method has been widely adopted by Indian companies such as Infosys, DSQ Software Ltd., Satyam Computers, BHEL and SPIC, it enables the company to benchmark the performance and the efficiency of their human resources with others. The assumptions in this model are realistic and scientific. The method has practical applicability when availability of quantifiable and analysable data is concerned.
Suggested methodology
We may adopt the basic premises of Lev & Schwartz model for valuing their human resources of a company after parallely ascertaining a human organisational inventory (HOS) to assess the effect of qualitative human variables (e.g., employee job satisfaction, 360 degree peer evaluation, etc.) on HR value.
In a nutshell, the approach involves valuing the employees of the organisation by projecting the current direct and indirect benefits (cost to company - CTCs) enjoying by the employees (a future cash outflow to the company) till retirement and consequently discounting the CTCs at the Weighted Average Cost of Capital of the firm (WACC) to arrive at the present value which is to be furnished in Annual Report. The WACC is calculated taking into consideration the target debt equity proportion, weighted average cost of debt, and cost of equity adjusted with company specific beta value, volume of trading and equity premiums. The optimum HR strategy for the future can be formulated by combining groupwise HR value, the findings from the HR inventory, and analysing the efficiency of the recruitment and training cost centres of the company..
Some basic assumptions for HR valuation
Each employee's cost to company (CTC) should be forecasted and discounted back separately. Thus a separate database comprising compensation details, age and experience details, historical promotion pattern for each employee should be constructed. The database serves as a powerful MIS tool for value interpretation.
The growth rate of earnings of each employee till retirement should be determined for projecting the CTCs after looking into the company's compounded annual growth in CTC's for different employee classes, global industry trends for the future (e.g., what happens after 5 years when the demand for Y2K jobs in the software sector obliterates), and sustainable growth rates for the next 25-30 years given the nominal interest rates of the Indian economy.
The attrition rates for the company / industry should not be considered as a deduction factor, as the employees who leave the company will be replaced by others to maintain the level of operations, and thereby the employee strength remains unchanged (conservation of employee stock / inventory). This is also consistent with the going concern concept.
Underlying meaning of HR value
The HR value per se throws valuable insights into the HR strategy of the firm. On one hand, it is a value of the employees of the company - thinking differently managements should realise that HR value is the future commitment which the firm has to pay to its employees for the career span in the company.
Thus, a high or low HR value will have to be justified with the returns it can achieve. Hence the return on HR value (ROHA) should be the efficiency measure of human resources on a year to year basis. The ROHA factor will assist management to manage the value / commitment better in future years. The HR turnover ratio can also be taken as an indicator of efficiency.
Companies can also make a conscious move to capture its costs related to HR department by developing a human resource accounting system which compliments the HR valuation exercise. The system can provide a cost clarity in all relevant areas related to the human resources of the company. In future, managements should begin to use HR value in regular MIS reports, in areas such as measurement of SBU profitability, SBU performance trend analysis, etc. which can fine-tune the appraisal system.
//Samrat Gupta is MIS Manager at DSQ Software Ltd., Chennai. An MBA from Manchester Business School.//
From India, Gurgaon
RESPECTED SIR,
YOUR CONTRIBUTION IS REALLY GOOD TO THE FORUM, I AM SEARCHING FOR A EXAMPLE CALCULATION OF HUMAN RESOURCE ACCOUNTING IN ANY COMPANY FOR MY MBA PROJECT. ANY WEBLINK, ARTICLE , ANY HELP.....
WITH ALL MY REGARDS
From India, Pune
YOUR CONTRIBUTION IS REALLY GOOD TO THE FORUM, I AM SEARCHING FOR A EXAMPLE CALCULATION OF HUMAN RESOURCE ACCOUNTING IN ANY COMPANY FOR MY MBA PROJECT. ANY WEBLINK, ARTICLE , ANY HELP.....
WITH ALL MY REGARDS
From India, Pune
Community Support and Knowledge-base on business, career and organisational prospects and issues - Register and Log In to CiteHR and post your query, download formats and be part of a fostered community of professionals.
03 Vangonotes HRM - Strategic Human Resource Management and the HR Scorecard.zip
HR Nothing Human, Just Plain Resources.pdf