By Jeff Higgins, CEO of Human Capital Management Institute (HCMI)
For hundreds of years, owners and managers have sought to quantify workforce productivity. This interest has intensified each decade up to the 21st century due to the increasing complexity and sophistication of business, technology, and the workforce. Today, it is imperative to identify and differentiate talent, as companies continue searching for ways to quantify workforce productivity and the differential value that top performers contribute versus average performers. In the past, when most jobs were direct sales or product manufacturing, the workforce was easier to measure via traditional metrics (such as sales per salesperson or number of widgets manufactured per worker).
In a world driven by services, data, and the internet, the measurement of productivity and talent has become increasingly difficult, yet more critical, due to the cost of technology and skilled workers needed to operate and drive today’s organizations.
Since modern workforce productivity is not easily quantified, this challenge requires a new approach and a consistent process. Such a process must measure workforce productivity in aggregate but more importantly, by job role. Such a process must also work across industry, geography, size, and complexity.
Why Haven't We Disclosed Human Capital Data in the Past?
Quite simply, human capital data has not been disclosed in any significant way because no disclosure is currently required by public company reporting entities. Organizations have executed unprecedented restructuring, retrenchment, and downsizing in recent years, yet most still lack the metrics to measure the workforce, or they measure everything and are unable to determine which numbers really matter in a meaningful way.
“Human resources can readily provide the number of people it hired, the percentage of performance evaluations completed, and the extent to which employees are satisfied or not with their benefits. But only rarely does it link any of those metrics to business performance.”
-- Keith Hammonds, Fast Company (Why We Hate HR, August 2005)
Workforce complexity, fluidity, a shortage of analysis skills in HR, and missing human capital reporting standards have contributed to the lack of confidence and minimal human capital reporting in existing financial statements today.
Measuring and Reporting Human Capital
What if it were possible to value the impact of human capital and quantify its contribution in the form of productivity or return?
What if the return on human capital could be definitively measured, quantified, and linked to business results by company, business unit, and even job role?
Imagine today’s financial investment marketplace without standard financial statements. Without financial statements, investors would be left on their own with little to no objective information with which to determine whether a company was a worthwhile investment or not. They would be left to rely to a great extent on the company’s own and potentially skewed information.
In such a situation, investors could be overwhelmed with unsubstantiated positive claims, in which organizations disclose what they consider fair and objective information that puts the best possible light on their performance.
Today, when it comes to evaluating an organization’s human capital, an environment similar to the one described above exists in HR. Organizations are open to making unsubstantiated talent claims regarding productivity, engagement, career path, training, and innovation. Nowhere in current disclosures or reports are they required to substantiate statements with facts or data.
Introducing Human Capital Financial Statements (HCF$™️)
Just as traditional financial statements allow investors to compare companies, gauge financial performance, and evaluate risk, so too can Human Capital Financial Statements (HCF$™️) provide bottom-line impact, tell a deeply contextual talent management gain and loss story, and spotlight human capital risks. Further, the flow of human capital can be measured and predicted, i.e. workforce planning, enabling HR to devise and implement strategic interventions to optimize building, buying or leasing talent, optimizing costs and critical roles among other strategies.
Human Capital Financial Statements developed by HCMI, represent three distinct statements, fulfilling functions similar to traditional financial statements. This function is to tell a comprehensive, contextual story that connects workforce performance to financial performance across multiple dimensions.
These three unique statements provide a wealth of value to companies and investors, as described below:
Human Capital Impact Statement - The human capital equivalent or supplement to the income statement, measuring quarterly or annual impact of human capital on financial performance. This statement measures the workforce impact on financial performance for a given reporting period.
Human Capital Asset Statement – Like a balance sheet, this statement quantifies the total value of the workforce, specifically the value of human capital at cost and the total value added over and above cost. It breaks down differential value contributions by job category and can drill down into critical job roles at a micro level to measure the ROI of specific job roles.
Human Capital Flow Statement - Similar to a cash flow statement, this schedule traces the flow of human capital across headcount, cost, and movement multiple dimensions by period such as a quarter or year, showing where and how human capital is allocated and used in an organization.
“Human Capital Financial Statements represent the endpoint HR has been searching for to standardize measurement and enable comparison of human capital performance across industry and geography.”
- Dr. Jac Fitz-enz - recognized as the father of human capital measurement.
A Supplement to Financial Statements, not a Substitute
Human Capital Financial Statements are not a substitute for current financial statements. They are a tool to measure the workforce as well as a resource for workforce insight and a supplement to a key success differentiator and source of future intangible value creation.
Company workforce costs should continue to be reported and treated conservatively as a period expense for traditional accounting and reporting, with one possible exception: the capitalization of qualified training costs.
These statements quantify trends in workforce productivity, costs, and value creation across the talent management lifecycle. Now we can clearly demonstrate a relationship between an organization’s financial performance and its workforce.
In practice, these statements can lead to a radical change in how organizations think and make decisions regarding their human capital. For example, a publicly traded international telecommunications company called Broadtek (a pseudonym), utilized human capital financial statements in a strategic discussion with the company's top management and the board of directors. The board, based on recent performance in traditional productivity metrics revenue and profit per full-time equivalent (FTE), was recommending a reduction in force.
Top management was convinced they had made substantial progress in controlling the Total Cost of Workforce (TCOW) and improved productivity by changing their workforce mix by selectively growing and investing critical roles while disinvesting and slowly reducing positions that added less value. As a result, Broadtek's top management, using human capital financial metrics, demonstrated to the board that Broadtek's workforce productivity was increasing by 13.5% per year, while competitor productivity was negative and showed no signs of improvement (see Figure 1 below). At the same time, Broadtek management had held TCOW growth to 4.4%, far less than the competitors’ ballooning 10% plus TCOW cost increases. The board not only agreed with management but also supported continued strategic investment in critical roles provided workforce cost targets were maintained.
Figure 1: BroadTek Human Capital Impact Statement (Workforce Productivity Impact Session)
(1) EBITDA = Earnings before interest
(2) Total Market Capitalization for publicly traded organizations or independent bank/financial market valuation for private entities.
Human Capital Financial Statements Answer Many Questions Starting With:
What impact does human capital have on financial performance?
What is the right number of employees and workforce cost?
What is the marginal return of $1.0 invested in the workforce?
What is the human capital value creation by different job roles?
What is the true cost impact of turnover?
Greater transparency into an organization’s stated “most valuable asset,” the workforce, and insight into management effectiveness with that most valuable asset. Transparency into knowledge capital fills a critical gap in today’s disclosure reporting.
A method to value knowledge capital. The world of business has changed and it is time that reporting and market disclosures changed with it. The drivers of market valuation today and in the future are far more knowledge capital than financial or physical capital. Today, knowledge capital is classified as intangible capital since no measures exist to make reasonable and accurate valuations. The Human Capital Asset Statement addresses that need. Adoption of the Human Capital Asset Statement can bridge this important gap and give everyone from credit rating agencies, banks, public reporting entities, and individual investors, an objective set of numbers and values with which to make better decisions about the true drivers of value.
Improved investment decisions, with better information, mean improved ability to assess future growth, particularly innovation and long-term value creation. This could lead to more efficient and effective deployment of human capital in organizations.
Supports standards for human capital reporting and analysis of human capital data for human resources, and the business. The Human Capital Financial Statements actually exceed the Society for Human Resources (SHRM) Human Capital Investor Metrics voluntary reporting standards. Further, these statements provide not just metrics but a methodology and framework with which to show whether the workforce and HR are creating significant value for the organization.
Enables benchmarking and comparison of a critical expense and differentiator of success.³ Standards enable deep benchmarking and identify best practices on a broad scale. Today’s benchmarking is often more anecdotal than objective and quantitative.
Links financial results to the workforce with both definitive measurement and a contextual story via high-level productivity metrics and quantifiable impact but also by individual talent management life cycle segments (such as recruiting, internal mobility, management and leadership, training, performance and engagement, and turnover/retention).
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³ Benchmarking Standards and Advanced Workforce Measures Provide Insight - For most financial ratio metrics, their primary value is in comparing or benchmarking them with competitors and peers in the same or similar industries, in particular for best-in-class performing organizations. For example, if an organization has an asset return ratio of 3.2 or a return on invested capital of 10%, one often cannot know if those numbers are good unless one knows what competitors and peers have for the same metrics. Improvement is always good however, if competitors are at 4.2, and 18% respectively your organization is in trouble. In short, benchmarking using standardized measures and metrics can be deeply insightful when compared to the proper context and benchmarks.
Such a set of metrics and reports enables HR and finance departments to integrate financial results with human capital metrics that quantify the bottom-line impact in recruiting, mobility, training, productivity, retention, and more. Ultimately, the possibilities for workforce optimization are limited only by data availability and systems that create a repeatable process.
While complex, such human capital reporting can be done and is being done by 100+ organizations
today. The real question is, if human capital is a critical differentiator in your business, why aren’t you doing it?
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For more detail on these and other foundational concepts as well as details on the metrics and calculations involved go to www.hcmi.co. Also, see the groundbreaking white paper entitled Human Capital Financial Statements (HCF$) here, and a case study here.
Jeff Higgins is CEO of the Human Capital Management Institute (HCMI). He is a driving force in workforce analytics and planning, helping to transform workforce data into intelligence and ROI. He has experience as both a senior HR executive and former CFO, with 15 years of experience in finance and accounting roles for companies such as Johnson & Johnson, Baxter International, and Colgate Palmolive. You can contact him at info@hcminst.com.
