formulas and calculation cases
HR ROI (from the English Return on investment, return on investment) is the percentage ratio between income and investment in personnel. To do this, we combine all personnel costs, including the cost of selection and training, and link them to income.
There are several options for accounting for HR-ROI:
HR-ROI = (Revenue – HR budget) / HR budget × 100%
For example, HR-ROI = (10 million – 2 million)/2 million *100% = 400%
where 10 million is revenue
2 million – personnel costs.
Sometimes C&B (all motivation costs) or only payroll (payroll) is taken into account, and this approach has its own justification.
The fact is that accounting using the formula HR-ROI (payroll) = (Revenue – payroll) / Payroll × 100% allows you to evaluate the effectiveness of working capital invested in salaries. Accounting for HR-ROI (payroll) in dynamics is carried out for operational response to inconsistencies. Everyone knows that the main indicator in business is revenue. It is easily calculated every month. It allows you to evaluate the effectiveness of the campaign, as well as determine the potential for growth or decline. There is another important indicator – profit. It is difficult to calculate it promptly (monthly) due to the income distributed over time and the labor intensity of allocating indirect expenses. HR-ROI (payroll) is a more predictive indicator for a business, because if the return on 1 ruble of investment in personnel falls even with existing revenue, then after some time the decrease in profit or revenue can be replaced. In other words, this indicator will signal you in advance about the potential for growth or decline.
Also, the advantage of this approach to calculating HR-ROI (payroll) allows you to evaluate the effectiveness of other HR functions that may affect it. For example, a well-built adaptation process will definitely increase HR-ROI (payroll). But for how long? We will know this if we do not take these costs into account in HR-ROI calculations. Well, or you’ll have to subtract them later.
HR-ROI (payroll) allows you to accurately distribute wage funds. For example, employees of departments that have the greatest influence on the company’s financial performance should earn more than service departments. Simply put, the biggest salaries should not go to the Chief Accountant and HR Officer, but to those who earn money for the company.
To effectively manage HR-ROI (payroll), you will have to digitize all personnel, that is, assign each employee an indicator in direct or indirect connection with the company’s financial performance.
There is also a formula that allows you to determine Personnel cost efficiency – this is the ratio of revenue per 1 ruble invested in personnel.
Personnel cost efficiency = 10 million/2 million = 5 rubles of revenue per 1 ruble of costs.
where 10 million is revenue
2 million – personnel costs.
Similarly, it is considered Labor productivity – this is revenue per 1 employee.
Labor productivity = 10 million / 100 employees = 100 thousand per 1 employee.
There is also a calculation share of personnel costs depending on revenue. For example, personnel costs are 2 million rubles. And revenue = 10 million. This means that personnel costs account for 20% of revenue.
The only true basis for allocating an HR budget is the connection between the HR function and the financial performance of the company
Some people associate costs with profits, but this is a mistake. Since the profit already includes the “cleaning” of personnel costs.
I consider it appropriate to use the gross income indicator. This is relevant for classic business.
Accounting for HR ROI is an attempt to reverse the owner’s viewpoint, where we transform personnel costs into investments in development, thereby assuming a percentage of their return. Simply put, we suggest that the owner treat his business like an investor, as if he were buying shares in the company and expecting results from them.
There is a practice of dividing personnel into categories and a separate topic of calculating the number of personnel in the whole company and for each category separately. HR-ROI calculations are also carried out separately by category.
Let's list these categories:
Front – personnel directly influencing revenue.
Back – administrative personnel whose work does not directly affect revenue. Accounting and HR here. But financial management and strategic HR may not fall into this category.
Service– support staff who influence revenue, although not directly. Other categories in production.
I also had individual projects, the effectiveness of which I considered either in comparison with the previous year’s revenue indicators, or a simultaneous comparison with indicators in divisions where the project was not carried out.
I would like to give an example of a company from Nizhny Novgorod. A supermarket chain launched a project in one of its stores, where trained staff at the checkout and behind the counter wish you well, health, happiness and all the best. Then they compared the revenue of this store with other stores and it turned out that in the supermarket where the experiment was conducted, revenue increased by 15%, and in other stores, due to the summer recession, on the contrary, revenue decreased by an average of 15%. We took feedback from customers, and most of them said that they consider such service special and they are very pleased with it. We analyzed in more detail the revenue of the store where the project was carried out, it turned out that the average bill fell, as in all stores, but customers began to visit the supermarket more often. As a result, all the directors of the supermarket chain lined up to have the same service format introduced to them.
The less budget allocated to HR functions, the less effective they are. But you're wasting money if you don't link it to business performance.
CasesHR-ROI
Sometimes the Customer’s application for personnel selection may be formulated not in the form of a description of the required competencies, but in the form of a goal that the Customer wants to achieve, for example, increasing revenue by 10 times in a certain division. And a solution is selected for this purpose, usually consisting of a whole team and several stages of implementation.
Case of a company selling medical devices from Vladimir. In a division with revenue of 110 million a year, the head was on maternity leave. Initially, the task was to find a temporary replacement for him, but with the prospect of business development. That is, the new employee must perform the functions of a manager until the main manager returns, and at the same time introduce new sales elements that affect revenue. The task was non-standard in that the division had extremely high productivity – only 2 employees, headed by a third – the Head of the Department, made revenue, distributing which to each of them, we get labor productivity higher than that of blue chips from the oil sector, placing shares on the stock market market. Their productivity was 36.5 million per employee. After a joint business analysis with the Customer, it turned out that the leader, a European company, was leaving the market. For a short period of approximately 1 year, in fact, a niche is formed in the market, which is an excellent opportunity for the Customer. This coincided with his long-term plans to make this direction more visible in the market, as in the old days. This market situation made it possible to count, if not on leadership, then certainly on increasing revenue, possibly significantly. The customer was offered 2 main options. The first option is a short-term use of the moment through headhunting of the Sales Director from the leader’s company and, as a result, the opportunity to double revenue. Thus, productivity could double, reaching 73.3 million per employee. The second option is to reproduce a full-fledged sales system similar to the one that worked for the leader, which means headhunting an entire team from the leader’s company. By hiring an additional 10 people, and at the same time increasing revenue by about 5 times, staff productivity would drop to 45.8 million per 1 employee (based on 550 million for 12 employees). This value is higher than the initial value, but still lower than the alternative – taking only the Sales Director.
The customer chose the second option and as a result, in 1 year, the division’s revenue increased from 110 million to 450 million, which amounted to 37.5 million per employee. If we consider this situation from the point of view of revenue per 1 ruble of payroll, then the new team was certainly much more expensive than the previous one. The old team, taking into account the regional location of the main office, had a total payroll of 250 thousand rubles per month or 3 million per year. Accordingly, for 1 ruble of payroll, the revenue was 36.7 rubles. And the same indicator in the new team was significantly lower – for 1 payroll ruble, revenue was 18.75 rubles, that is, it decreased by almost 2 times (based on payroll 2 million per month or 24 million per year for 450 million revenue).
But why did the owner agree to the situation in the example?
It is important to take into account that the result obtained is an increase in revenue and a decrease in staff efficiency; this is just one side of the case, and only the beginning of the development of a sales system and gaining a noticeable share in the market. The customer expects a further increase in sales with a simultaneous increase in marketing indicators and brand awareness, thus gradually winning an increasing share of the market.
In this case, the owner is distinguished by strategic thinking and the ability to invest long-term in the future, accepting the risks of loss of benefits in the present.
Should HR BP dive so deeply into the strategic level of the business?
I am sure that many of you doubt that an HR business partner is obliged to operate with such calculations. And I agree, in fact, it is still rare to hear a request from business for such HR BP. But this business need has been heard for a long time, and here’s what else I would like to add in the context of the above-mentioned case. The more strategic the level of HR BP partnership with the business, the more issues are discussed about revenue and profit, the higher the value of HR BP for the Customer in particular and the company in general.
I often draw a parallel between HR and marketing. But did you know that not all companies have well-developed marketing? The problem of developing marketing (as well as IT and other functions) is the same as in personnel management – function leaders do not always know how to connect their function with revenue. And in this case, there is another important additional value of a high-level HR BP – it should be able to connect not only its function with the financial performance of the company, but other functions too. Should he know all the calculation formulas? Definitely no. But he must definitely be able to identify and highlight candidates with such knowledge, and convince Customers of their advantage.
