Recently on the HRMAE LinkedIN discussion page it was brought up that “You can’t play in the corner office if you don’t understand the language [Finance].” ~ Don Schepens, Past-president HRMAE.
So if you are an HR person who doesn’t like Finance, or a longtime HR professional who wants to be more effective by using finance principles, read on.
Return on Investment (ROI): This calculates the “benefit” from spending money now. This is calculated as follows: ROI = [future benefit – current cost] / current cost. This is usually quite simple for something like a new assembly line machine which improves productivity by $3,o00/day, and lasts 3 years = $1,095,750. The machine itself costs $750,000, therefore:
- ROI = [$1,095,750 – $750,000] / $750,000 = 0.461 = 46.1% return on investment
So how can you, as an HR professional use this? You already know the expenses of your area and projects, so start tracking the benefits. If it costs roughly ~$5.00 to train an employee to be better at sales. This training increases their sales by $10, we can see the ROI of a sales training program is 100%. When you bring forward your programs with this sort of evidence it provides you far more clout at the table.
Break-even Analysis: This is when gains = loses. This is one of the most powerful tools for evaluating and planning for a program. How to calculate break-even (units). Fixed Costs / [Price – Variable Cost]. For exmple, if we are hosting an employee conference, and the divisions have said they will provide $50 per employee who attends. The conference centre charges $12,000 for the day, and the catering is $12.50 per attendee, how many employees will need to attend to ensure HR’s budget is not required to cover the conference?
- $12,000 / [$50 – $12.50] = $12,000 / $37.50 = 320 employees.
This would also be a good time to look at the capacity of the conference centre to ensure it can hold at least 320 employees. I remember a colleague doing an incredible job on an employee conference once, only to learn that because of poor reporting from the years previous event (over-reported attendance by nearly 20%), the chosen venue for the coming year could not have held the number of attendees the executive were hoping for.
Net Profit: Okay, I lied, this one isn’t exactly a formula like the other two. But it’s versatile when combined with other numbers, and when people talk about the bottom line…this is it. So here is net profit:
Revenue: $ 100
Cost of Goods Sold $ 30
———————————–
Gross Profit: $ 70
Operating Expenses $ 30
———————————–
Operating Profit $ 40
Taxes
$ 10
———————————–
Net
Profit
$ 30
So, now that we know Net Profit, what can we do with it? How can we improve it? Well there are a couple ways, first we could improve how efficiently we make the product (lowering cost of goods sold). Secondly (and key to HR) we can lower operating expenses – this is almost exclusively done by lowering headcount. Lastly we could increase revenue by selling more of our products. So that’s how Net Profit is impacted, but what about using it? My personal favourite is ratios, in particular profit-per-employee ( Net Profit / Number of Employees). So, a company with $1,000,000 / 200 employees = $5,000 profit per employee, which is a great measure of the effectiveness of your workforce. You could also compare training dollars spent versus net profits to determine the effectiveness of those programs from year to year.
So, those are three formulas any HR professional should understand. If you have any questions, or want to suggest your own please leave a comment or head over to our linkedIN page to discuss.
Tyler Totman
twitter: @FAPhoenix