What HR practitioners must understand in finance

1. Understanding financial
human resource in relation
to business
Paper 4
Arriffin Mansor
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2. Contents
• What is HR accounting?
• What is the value of human?
• Why is HR accounting?
• The importance of Human Capital Asset
• Present accounting ignores the human capital
• Return on pay
• Human capital architecture.
• Costs related to human capital
• Human Resources
• Future development
• Researh and development
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3. What is human resource accounting?
• To record, report and analyze human resource
related figures through the accounting system
• The result can be use for planning and
decision making purpose
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4. What is the value of human?
• Human is priceless.
• Human capital can be counted.
– How do you calculate the value of an employee in
the company?
• Minimum value = The present value of her(his) salary in
the future, by considering the possibility of early
absence.
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5. Why human resource accounting?
• Human capital becomes the most important
asset in the corporation to extract value
• Present accounting system ignores the
importance of human resource value
• Managers lack information about the
effectiveness and efficiency of human
resource investment
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6. Human capital becomes the most important
asset in the corporation
• More service(human intelligence) oriented
company than before
– Higher Tobin’s Q(Price/Equity)
– Higher Return on Assets(ROE)
• The importance of capital shifts from financial
capital to intellectual capital
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7. Ku-Jun Lin, Associate Professor, Tam Kang University
• Intellectual capital including
– human capital,
– organizational capital
• Relation capital(outside)
• Customer capital(outside)
• Process capital(inside)
• Learning and development capital(inside)
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8. Review: Major Balance Sheet Items
Assets Liabilities and Equity
• Current assets: • Current liabilities:
– Cash & securities – Payables
– Receivables – Short-term debt
– Inventories • Long-term liabilities
• Fixed assets: • Shareholders' equity
– Tangible assets
– Intangible assets
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9. Objectives of Ratio Analysis
• Standardize financial information for
comparisons
• Evaluate current operations
• Compare performance with past
performance
• Compare performance against other firms
or industry standards
• Study the efficiency of operations
• Study the risk of operations
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10. Rationale Behind Ratio Analysis
• A firm has resources
• It converts resources into profits through
– production of goods and services
– sales of goods and services
• Ratios
– Measure relationships between resources and financial
flows
– Show ways in which firm’s situation deviates from
• Its own past
• Other firms
• The industry
• All firms-
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11. Types of Ratios
• Financial Ratios:
– Liquidity Ratios
• Assess ability to cover current obligations
– Leverage Ratios
• Assess ability to cover long term debt obligations
• Operational Ratios:
– Activity (Turnover) Ratios
• Assess amount of activity relative to amount of
resources used
– Profitability Ratios
• Assess profits relative to amount of resources used
• Valuation Ratios:
• Assess market price relative to assets or earnings
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12. The DuPont System
ROE
ROA E q u ity M u ltip lie r
P ro fit M a rg in T o ta l A s s e t T u rn o v e r
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13. The DuPont System
ROE
ROA E q u ity M u ltip lie r
P ro fit M a rg in T o ta l A s s e t T u rn o v e r
ROE = ROA × Equity Multiplier
Net Income Total Assets
= ×
Total Assets Common Equity
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14. The DuPont System
ROE
ROA E q u ity M u ltip lie r
P ro fit M a rg in T o ta l A s s e t T u rn o v e r
ROA = Profit Margin × Total Asset Turnover
Net Income Sales
= ×
Sales Total Assets
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15. The DuPont System
ROE
ROA E q u ity M u ltip lie r
P ro fit M a rg in T o ta l A s s e t T u rn o v e r
ROE = Profit Margin × Total Asset Turnover × Equity Multiplier
Net Income Sales Total Assets
= × ×
Sales Total Assets Common Equity
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16. The DuPont System: Dell
Net Income Sales Total Assets
ROE = × ×
Sales Total Assets Common Equity
= Profit Margin × Total Asset Turnover × Equity Multiplier
= ROA × Equity Multiplier
$1,666.00 $25,265.00 $11,471.00
ROE = × ×
$25,265.00 $11,471.00 $5,308.00
= 0.0659 × 2.2025 × 2.1611
= 0.1452 × 2.1611
= 31.39%
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17. Summary of Financial Ratios
• Ratios help to:
– Evaluate performance
– Structure analysis
– Show the connection between activities and
performance
• Benchmark with
– Past for the company
– Industry
• Ratios adjust for size differences
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18. Limitations of Ratio Analysis
• A firm’s industry category is often difficult to
identify
• Published industry averages are only
guidelines
• Accounting practices differ across firms
• Sometimes difficult to interpret deviations in
ratios
• Industry ratios may not be desirable targets
• Seasonality affects ratios
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19. Ratios and Forecasting
• Common stock valuation based on
– Expected cashflows to stockholders
– ROE and ρ are major determinants of cashflows to
stockholders
• Ratios influence expectations by:
– Showing where firm is now
– Providing context for current performance
• Current information influences expectations by:
– Showing developments that will alter future performance
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20. How Might Ratios Help Me on the
IEM?
• Analysis of AAPL, IBM and MSFT, and comparisons to
the S&P500 companies can help to:
– Assess the (absolute and relative) financial state of each
company
– Show each company’s strengths and weaknesses
– Predict sustainable growth rate
• Combined with current information, this can help to:
– Assess likely future performance
– Predict future valuation and earnings growth
– Predict returns
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21. • Characteristics of Human capital
– Hard to imitate
– Causal ambiguous
– Cannot duplicate in a short time
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22. Present accounting system ignores the
importance of human resource value
• Generally Accepted Accounting Principle(GAAP)
treats most human capital related costs as
expenses, instead of assets
• The more the company invests in human capital,
the less the current net income
• Revenue-Expense(including HR)=Net Income
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23. • Financial ratios, based on financial
statements, provide little or bias human
capital profitability information, for example
– ROA: based on hard asset
– Return on Investment(ROI): The “I” represents the
investment on hard assets
– Assets Turnover: Sales/Total “hard ”assets
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24. How about Return on Pay?
• Not all post could be associated with ROA.
• Jobs at the lowest level has only Pay to
contend with.
• Hence, return on pay could be meaningful in
evaluating the performance of a job holder.
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25. • Reasons why GAAP does not allow human
capital investment becomes assets
– Future benefit uncertainty
– Conservatism
– Ethical issue
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26. Managers lack information about the
effectiveness and efficiency of human
resource investment
• Lay off decisions
– Does the lost training cost and future
orientation cost be considered?
– Short term, immediate positive impact on
current net income VS effect on long term
profit
– Impacts on employee’s feeling which may
negatively influence company income
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27. • Investment in human capital decisions
– Where is the beef?
– What is the relationship between human capital
investment and operation result?
– The communication of company human capital to
investors.
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28. The Human capital Architecture
• The classification of Human capital
– Not all employees are classified as human capital
– Value VS Uniqueness(Lepak & Snell, 1999)
– High value Employees can be considered as
human capital
– Human capital in quadrant 1are most valuable 123
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29. Accounting in HR
• Is HR expenditure an asset or an expense?
• How do you value HR in the Balance Sheet?
• How do you justify a worker? ROA or ROP
• How do you measure efficiency and profit
contribution by each employee
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30. Costs related to human capital
• 1. Formation and acquisition costs at the early
stage of development, eg. Recruiting cost
• 2. Learning costs in the middle stage of
development, eg, Training cost
• 3. Replacement costs at the final stages of
development, eg, discharge cost
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31. Human resource factors that may have
influence on operation result
• Financial(human resource accounting, use
accounting system to collect data)
• Non financial(use questionnaire)
– Personal background, such as age, gender,
education, experiences and licenses.
– Personal characteristics, such and personal traits
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32. Research summary
Ku-Jun Lin, Associate Professor, Tam Kang University
• If we consider human capital cost as the only
variable, usually it does not show significant
influence on operation result in most companies.
• However, if we use an intermediate variable, such as
customer capital between human capital and
operation result, usually human capital would
demonstrate significant influence on operating result
through the intermediate variable.
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33. • Some personal background and personal
characteristic, together with human capital
cost, do have significant influences on
operating results
• Capitalizing human capital cost may improve
the quality of earning.
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34. The Limitation
• Hard to find specific human resource data
• Case study rather than general study
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35. Future development of HR accounting
• The influence of market value
accounting(such as the evaluation of
investments) on human resource
accounting
• R & D cost also faces the future benefit
uncertainty problem, does the accounting
treatment for R & D provide any guidance
for human resource cost?
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36. Closing Summary
• Is it an asset or expense? Is training an asset
or expense?
• How is HR represented in the Balance Sheet?
• How do you evaluate the performance of a
worker? ROA or ROP
• How to identify critical performance gaps for
TNA purposes.
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37. Thank you for listening
Q&A
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