Human capital financial statements: the missing link between human capital and financial results

Jeff Higgins

For hundreds of years, owners and managers have sought to quantify workforce productivity. This search has intensified each decade into the 21st century due to the increasing complexity and sophistication of business, technology, and the workforce. In today’s competitive global economy, it is more important than ever for companies to quantify, assess, and differentiate the value that their top performers contribute over the average performers.

When most jobs were direct sales or product manufacturing, the workforce was easier to measure by traditional metrics, such as sales per salesperson or number of widgets made per worker. However, in a world driven by services, data, and the Internet, 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.

Modern workforce productivity is not easily quantified. It requires a new approach and a consistent process to measure it in aggregate and, more importantly, by job role. It must also work across industry, geography, size, and complexity.

Why we haven’t disclosed human capital data in the pastHuman capital data has not been disclosed in any significant way because it is not 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 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 standards have contributed to the lack of confidence and minimal human capital reporting in existing financial statements.

Measuring and reporting human capitalWhat if it were possible to value the impact of human capital and quantify its contribution in the form of productivity or return? And 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. Investors would be left on their own with little to no objective information with which to determine whether a company was a worthwhile investment. They would be left to rely to a great extent on the company’s own potentially skewed information.

In such a situation, investors could be overwhelmed by unsubstantiated positive claims by organizations disclosing what they consider fair and objective information that puts the best possible light on their performance.

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 make 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 StatementsJust 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 in the manner of 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.

HCF$, developed by Human Capital Management Institute (HCMI), fulfill functions similar to traditional financial statements — telling a comprehensive, contextual story that connects workforce performance to financial performance across multiple dimensions. The three unique statements provide a wealth of value to companies and investors:

• Human Capital Impact Statement. The human capital equivalent or supplement to the income statement measures quarterly or annual impact of human capital 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 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 by a period, such as a quarter or year, showing where and how human capital is allocated and used in an organization.

A supplement to financial statements, not a substituteHCF$ are not a substitute for financial statements but rather a tool to measure and provide insight into the workforce and a key success differentiator supplement. 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 about their human capital. HCF$ answer many questions, including:

• 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 $1.00 invested in the workforce?
• What is the human capital value creation by different job roles?
• What is the true cost impact of turnover?

Gains from adopting HCF$ begin with the following:

1. Greater transparency into an organization’s stated most valuable asset, the workforce, and insight into management effectiveness with that most value asset. Transparency into knowledge capital fills a critical gap in today’s disclosure reporting.

2. A method to value knowledge capital. The world of business has changed, and it is time that reporting and market disclosures change with it. Knowledge capital has been classified as intangible since no measures existed to make reasonable and accurate valuations. The Human Capital Asset Statement bridges this gap and gives 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.

3. Improved investment decisions with better information leading to improved ability to assess future growth, particularly innovation and long-term value creation. This can lead to more efficient and effective deployment of human capital in organizations.

4. Standards for human capital reporting and analysis of human capital data for human resources and the business. HCF$ actually exceed the Society for Human Resources Management (SHRM) Human Capital Investor Metrics voluntary reporting standards. Further, these statements provide not just metrics but also a methodology and framework with which to show whether the workforce and HR are creating significant value for the organization.

5. Benchmarking and comparison of a critical expense and identifying best practices on a broad scale. Today’s benchmarking is often more anecdotal than objective and quantitative.

6. Linking financial results to the workforce with both definitive measurement and a contextual story via high-level productivity metrics and quantifiable impact as well as by individual talent management life cycle segment, such as recruiting, internal mobility, management and leadership, training, performance and engagement, and turnover/retention.

Such a set of metrics and reports enables HR and finance departments to integrate financial results with human capital metrics that quantify bottom-line impact in recruiting, mobility, training, productivity, retention, and more. Ultimately, the possibilities for workforce optimization are limited only by data availability and by systems that create a repeatable process.

While complex, 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?

For more details on these and other foundational concepts, as well as details on the metrics and calculations involved, go to www.hcminst.com. Also see the groundbreaking white paper entitled Human Capital Financial Statements.Reprinted with the permission of Jeff Higgins, CEO of the Human Capital Management Institute, and the driving force in workforce analytics and planning, helping to transform workforce data into intelligence and ROI. For more information, email jeff.higgins@hcminst.com.