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
2
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
3
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.
4
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
5
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
6
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)
7
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
9
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-
10
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
11
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
12
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
13
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
14
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
15
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%
16
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
17
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
18
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
19
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
20
21. • Characteristics of Human capital
– Hard to imitate
– Causal ambiguous
– Cannot duplicate in a short time
21
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
22
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
23
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.
24
25. • Reasons why GAAP does not allow human
capital investment becomes assets
– Future benefit uncertainty
– Conservatism
– Ethical issue
25
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
26
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.
27
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
28
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
29
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
30
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
31
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.
32
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.
33
34. The Limitation
• Hard to find specific human resource data
• Case study rather than general study
34
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?
35
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.
36
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Balance Sheet Statement of financial position at specific point in time Shows assets owned by the firm and sources of the money used to purchase those assets. Liquidity Order Assets: length of time typically to convert to cash Liabilities: how soon must be paid Characteristics Cash versus other assets Only cash represents actual money Noncash assets should produce cash in time Liabilities versus stockholders’ equity Both claims against assets Breakdown of common equity accounts Common stock Retained earnings Impacted by Inventory accounting Depreciation methods Position at one point in time
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Uses 1. Managers – to help analyze, control, improve a firm’s operations 2. Credit analysts – to help ascertain a company’s ability to pay its debts 3. Stock analysts – to determine a company’s efficiency, risk and growth potential
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Liquidity Ratios: Current Ratio Quick (Acid Test) Ratio Cash Ratio Net Working Capital to Total Assets Leverage Ratios: Total Debt Ratio Debt to Equity Ratio Equity Multiplier Long-term Debt Ratio Times Interest Earned Ratio Cash Coverage Ratio Activity (Turnover) Ratios: Inventory Turnover Days’ Sales in Inventory Receivables Turnover Days’ Sales in Receivables NWC Turnover Fixed Asset Turnover Total Asset Turnover Profitability Ratios: Profit Margin Return on Assets Return on Equity Valuation Ratios: Price to Earnings Market to Book
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Notice that using more debt (and less equity) to finance assets raises the Equity Multiplier. This has two effects for stockholders. The Equity Multiplier acts as a lever to magnify the effects of ROA on returns for stockholders. If ROA is positive, ROE is a larger positive value, but if ROA is negative ROE is a larger negative. Raising the s magnifying effect also raises the risk for stockholders.
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Return on Assets is affected by two areas of operations. The Profit Margin measures the degree to which the firm controls expenses. Since expenses comprise the difference between Sales and Net Income, lowering the expenses taken out of each dollar of sales raises the Profit Margin. At the same time, Return on Assets can be raised by producing sales by using fewer assets. Asset Turnover measures the dollar of sales produced with each dollar invested in assets. This is often thought of as sales volume. Different industries achieve ROA in different ways. Some have low profit margins but high volume, e.g. grocery stores. Others have lower volume but are able to maintain higher profit margins, e.g. car dealerships.
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Dells ROE 31.39% is higher than the industry standard (24.1% average over the past 4 years). Where is Dell making these high profits? Dell’s ROE comes from: Dell’s profit margin is 6.59% The industry average over the preceding 4 years is only 3.69%. So, Dell is nearly twice as efficient as the industry average in generating profits from its sales. Dell’s sales-to-assets ratio is 2.20. The industry average over the preceding 4 years is 2.05. So, Dell is about average is generating sales from its assets. Dell’s equity multiplier is 2.16. The industry average over the preceding 4 years is 2.50. So, Dell is a little below average in its equity multiplier (using a little more equity and a little less debt than an average company in the industry.) Thus, we can conclude that Dell’s profitability comes from it’s operating efficiency!
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Knowing the absolute level of a single entry on the income statement or balance sheet doesn’t provide sufficient information to evaluate performance. Ratios help by focusing on relationships among entries on the financial statements. The ratios in the DuPont system show the connection between the firm’s operations, its capital structure and the returns for investors. Because a firm’s size affects financial statement values, it’s hard to evaluate performance using absolute levels. By controlling for differences in size to make comparisons ratios facilitate the evaluation of a firm’s performance.
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Limitations 1. Large firms operate different divisions in different industries a. Difficult to develop meaningful industry averages b. More useful for small, narrowly focused firms 2. Firms want to be better than average a. Attaining average performance not necessarily good b. Best to focus on industry leaders’ ratios 3. Inflation may have distorted balance sheets a. Must consider effects when comparing over time 4. Seasonal factors distort ratio analysis a. Use monthly averages for season items such as inventory 5. Window dressing can make financial statements look better 6. Different accounting practices can distort comparisons a. Inventory valuation, depreciation methods 7. Difficult to generalize whether a ratio is “good” or “bad” a. High current ratio – strong liquidity or too much cash (nonearning) 8. Ratios can give “mixed” view of company a. Analyze net effects of a set of ratios
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz Stock prices can be thought of as discounted present value of expected future dividends. Dividends are paid out of earnings. Therefore expectations of future dividends would be based on current earnings (ROE) and sustainable growth rate on earnings. Ratio analysis can help evaluate current performance as well as firm’s likelihood to be able to sustain performance. High current ROE that is the result of high Equity Multiplier implies higher risk for stockholders. High ROE that derives from high ROA is less risky and possibly more sustainable.
Financial Statement Analysis October 2000 C.J. Brown, M.M. Dutton and T.A. Rietz