Chapter 24
Human capital value added (HCVA)
- Why: To better understand the financial value employees are generating
- What: To measure the financial contribution each employee makes to the organisation
- When: When companies and shareholders want to understand the financial contribution per employee
- The question this indicator helps you to answer: to what extent are our employees adding value to the bottom line?
Why does this KPI matter?
In many businesses, employees are not only the most important assets and key enablers of future success but often the biggest expense (or rather investment). It is therefore important to understand to what extent employees add value to the financial performance of the organisation. Employees are often a missing ingredient in accounting and finance (except as an expense) and with a little effort we can calculate the effects of people on financial performance.
Research finds that while most businesses have a range of HR indicators, less than half actively track the impact of employees on financial business performance. The reason I am often given for not using such measures is the argument that there are no agreed or valid ways of calculating this. Here I would like to quote human capital guru Dr Jac Fitz-enz, who says: ‘To contend that there is no valid and consistent way to do this is simply to admit one’s ignorance.’
In the past, companies used over-simplified KPIs such as revenue per employee. If businesses are to understand the real profit impact of employees then we need to calculate human capital value added (HCVA). To get to the HCVA we take all non-employee-related expenses away from the revenue generated and divide this (adjusted profit figure) by the number of full-time employees. HCVA therefore gives us the profitability of the average employee.
How do I measure it?
How do I collect the data?
The data for this can be easily extracted from the financial accounting systems or the financial statements.
What formula do I use?
The PWC Saratoga Institute suggests calculating HCVA by subtracting all corporate expenses except for pay and benefits from the revenue generated and dividing the adjusted profit by the average headcount.
where total costs are the difference between revenue and profit before taxes, employee cost is pay and benefits, and FTE is the average number of full-time employees.
How often do I measure it?
A quarterly calculation of HCVA is recommended.
Where do I find the data?
The source of the data will be the financial accounting system.
How difficult or costly is it to measure?
The costs for collecting and calculating this KPI are minimal, as companies will already have all the financial information in their financial statements.
How do I set targets for this KPI?
As profitability per employee goes, the bigger the better really. It is impossible to provide a generic benchmark here and it is probably best to track this indicator over time with an aim of increasing the figure.
Practical example
Let’s look at a company with the following figures:
- Revenue is $100,000,000.
- Total costs are $80,000,000.
- Employee costs are $30,000,000 ($20,000,000 in pay and $10,000,000 in benefits).
- Number of employees is 650.
Some tips and traps to consider
Just looking at the costs for full-time employees can sometimes slightly distort the picture, as most businesses incur further employee-related expenses such as the cost for contingencies, absence and turnover. These can be added to the formula.
Also, some suggest1 that the profit before tax figure is not a correct profit item, as foreign exchange losses are included in it. The benchmark may be reasonable in developed countries where devaluation does not exist. Instead, you can calculate total cost as the difference between revenue and operating profit. The formula then will be:
And to simplify the calculation:
Further reading and references
Jac Fitz-enz, The ROI of Human Capital: Measuring the Economic Value of Employee Performance, New York: AMACOM, 2009.
Nancy R. Lockwood, Maximizing Human Capital: Demonstrating HR Value with Key Performance Indicators, SHRM, 2006. www.shrm.org/Research/Articles/Documents/0906RQuartpdf.pdf
Leslie A Weatherly, The Value of People: The Challenges and Opportunities of Human Capital Measurement and Reporting, SHRM. www.shrm.org/Research/Articles/Articles/Documents/0303measurement.pdf
1 http://humancapitalstrategy.blogspot.com/2009/09/measuring-employee-value-added.html