The human resources department tends to have the least direct impact on a company’s financial performance in the short term, because it controls a relatively small number of expenses. However, there are two instances in which it can have a significant impact. One occurs when the revenue per employee is relatively small, so that any changes in per-employee costs will have a significant impact on overall corporate profitability. In this instance, any significant change in the cost of benefits per employee will have a major impact on profits. The other instance occurs when a company is on a fast growth path, where the human resources staff can reduce the rate of growth through its failure to locate a sufficient number of new employees to support the additional sales.
Through this post I am going to show you how to analyze performance of the human resource department to address two main issues mentioned on the above preface. The remainder of this post clusters five key analyses to measure the human resources department around benefit costs and recruiting success [i.e. employee turnover, recruiting cost by method, recruiting success by method, training cost per hour, and average time to hire]. Every analysis yields result that will become valuable input to decision making for the human resources department. I believe this post will help some people who are in the area of financial control, i.e. Financial Analysts, Controllers or CFOs or even the business owner. Enjoy!
Analyzing the Trend of Benefit Costs Per Employee
In the area of benefit costs, the key measurement is the trend of benefit costs per employee, broken out for each benefit. It is also useful to include the employee participation percentage in the same chart, along with the grand total cost of each benefit. By presenting this information in such a format, it becomes a simple matter to determine where costs are rising, whether or not employees care to use them, and the total cost impact of each one. The information should be updated on a rolling basis once a month in order to spot and correct sudden cost increases. An example of this chart is shown below:
A key factor to consider when reviewing this chart is that total benefit costs may go up, but the fault does not lie with the management of costs by the human resources department—instead, the employee participation rate has increased, resulting in more costs. Consequently, it is important to compare the cost per person and participation percentages to determine the true reason for an overall benefit cost increase.
Also, notice the jump in per person costs in medical expenses as the participation rate drops in the previous example. This is a common problem for the financial analyst to see, and is caused by an increase in per-person prices by the health insurance company because the company has dropped below a minimum number of participants. Thus, human resources costs can jump outside of expected ranges if the participation levels drop or increase beyond historical rates.
The 401k cost per person can be difficult to estimate for small groups, since there may be a few participants who will invest disproportionately small or large amounts, resulting in wide swings in the cost a company invests in matching programs. However, for larger groups of participants, these variations tend to average out, resulting in highly predictable expenses. Nonetheless, this cost is also subject to wide variation if management decides to alter the terms of the plan, such as automatically enrolling all new employees in it, unless they specifically request to be left out. In this case, the administration cost will increase, because there are more participants, and the matching cost will increase, because there are more people investing in the plan. Accordingly, any large change in investment costs should lead an analyst to suspect that there has been some change in the plan rules that has caused the variation.
Analyzing Recruiting Efforts Success
A company’s success in its recruiting efforts is of paramount importance to those companies that are on a steep growth path, because they are in dire need of large staff increases to help support their growth. If these recruiting needs are not met, a company can find itself pursuing a much slower growth curve than would normally be the case, which has a major impact on profitability.
Accordingly, a financial analyst in such a company should always spend considerable time reviewing the success of the human resources department in attracting new talent. There are five key analyses to be used as discussed below.
The human resources department has a direct impact on the percentage of employees who leave a company each year, because it controls the benefits. If the benefit levels are poor, the turnover rate will be higher than would normally be the case.
The turnover calculation is:
Number of employees leaving the company in a month / [(Employee head count at start of month + Head count at end of month)/2]
A number of additional costs are associated with employee turnover that are difficult to quantify and that cannot be expressed in a simple ratio. These costs include: job advertising, aptitude testing, drug testing, and higher workers’ compensation claims.
Other costs that resist measurement are on-the-job training, management time to review resumes and interview staff, human resources time to process new employees, a reduction in team productivity while they assist new staff, and the possible loss of customers due to inadequate servicing. The controller should provide some estimate of these costs as part of the employee turnover calculation. By doing so, management can decide if it is cost effective to increase benefits or improve working conditions in order to retain a larger proportion of employees, thereby avoiding turnover costs.
Recruiting Cost by Method
The recruiting cost per hired employee can be excessive if the wrong methods are used, such as exclusive reliance on recruiting firms, which typically charge 30 percent of each recruit’s first-year pay as their fee. A broader mix of recruiting methods, such as referral bonuses, Web sites, newspaper ads, and trade journal ads, will result in a lower total recruiting cost. If there are many new employees being added, this can be an annual difference in recruiting costs of millions of dollars.
An important issue here is that a human resources department may be forced into more expensive recruiting methods as the local pool of talent dries up, possibly due to competition from other firms, a lack of local colleges, or the high growth rate of the company. Thus, the recruiting cost may, to some extent, be beyond the control of the company.
This calculation is:
Number of employees hired / Cost by recruiting method
Note: This calculation is designed to yield a recruiting cost per person, which can then be tracked on the table shown below to determine changes in costs by recruiting method over time.
Recruiting Success by Method
Some recruiting methods may work better than others, depending on the geographic region or the type of person being recruited. For example: Web site advertisements will not work well if a company is hiring manual laborers, because these people are highly unlikely to own computers for browsing the Web. Accordingly, it is necessary to trace the success of each recruiting method to determine where the human resources staff should focus its efforts.
Formula for recruiting success by method is:
Number of people accepting offers based on each recruiting method / Number of people initially contacted by the company based on each recruiting method
Note: It is best to use this measure for no less than quarterly time periods, since the recruiting period needed to hire anyone can easily take this long. A shorter time period might not accurately reflect the number of people actually hired.
Training Cost Per Hour
Even if a sufficient number of employees are brought into a company, they may not be effective if they are not sufficiently trained for assigned tasks, resulting in low levels of efficiency and high employee turnover rates, which will still result in lower-than-expected sales. This is a particular problem for high-growth companies in the retail industry, in which the majority of incoming recruits are severely undertrained. Alternatively, this is not a relevant issue in the high-tech industry, where all recruits are expected to be fully trained prior to hiring.
Training cost per hour calculation is:
Total training cost related to employees hired within past 90 days / Number of hours of training devoted to employees hired within past 90 days
Note: The total training cost may require an allocation of training overhead charges to the training devoted to new employees. If so, add overhead costs based on the proportion of training hours for new employees to the total amount of training hours offered by the company during the period.
Average Time To Hire
A key function of the human resources department is its ability to hire staff within a reasonable period of time. This process can be difficult and lengthy and subject to the opinions of the interviewers, thereby making it an even longer process that is not entirely under the control of the human resources department.
However, it is possible to judge the recruiting performance of the human resources department to some extent by using a measurement of the average time required to hire employees.
The Average Time To Hire formula is:
Sum for all completed job searches ( Job application date ? Job application date) / Number of completed job searches
All analyses revealed in this post should be more than enough to catch financial—related issues in the human resources department and raise some intelligent approach to fix the problems. Of course, there are plenty of off-topic analyses commonly used by human resources managers to measure employee’s performance which I don’t discuss in this post.