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The Premises Considered in Calculating ROI for New Hires
In the accounting system of measuring the overall performance of the business, the traditional formula for ROI is expressed as:
ROI = Net Income / Book Value of Asset
This formula represents the proportion of entire company earnings over its entire investments.
We will use the same formula in calculating ROI for hiring employees, but the costs included are those that are directly and indirectly incurred in the process of recruiting and selecting the new members of the workforce. This aspect represents the investment or money used to realize profit, whereby the workforce is the company asset being considered.
Examples of these costs are classified ad job postings, administrative wages of Human Resources (HR) personnel who administer the tests and conduct the interviews, testing materials, background checks, orientation and training costs. Indirect costs will include the separation pay of exiting employees as well as the loss of productivity during the period that the position was left vacant.
In order to match revenue against cost, an estimate of revenues will consider only that part of the benefit realized by the company, that is reflective of the efficiency contributed by the new members of the workforce hired during the year.
Hence, if the HR group reduces its hiring costs for the current year, this would mean that the company’s operation has the potential to increase its net income by the amount of the cost reduction initiated by the Human Resources department. The use of this concept in calculating ROI is called Cost Reduction.
Another way to compute ROI for fresh employees is by determining the increase in revenue, with the assumption that the new employees contributed to this increase; hence this method is called Increased Income.
These are now the premises by which two different methods of calculating an ROI benchmark for new hires will be discussed in the following sections.
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The Cost Reduction Method
This method may involve the introduction of a new system of hiring or the implementation of cost cutting measures, wherein the current year’s budget for recruitment and hiring processes would be greatly reduced by a specific amount. The said amount of reduction will be considered as HR’s estimated share in income generation.
To illustrate this by example, the following is a management forecasting decision where the given values will be used to calculate ROI:
In 2008, the company’s HR department incurred actual costs of $250,000 and the Net Income generated for the year was $215,000 in direct costs and $60,000 in indirect costs. Management decided to reduce the department’s 2009 budget to $175,000. Part of the budget was utilized for recruiting and hiring 30 additional workers with an equivalent additional cost for the year of $150,000. Based on management’s estimate, the reduction plus the new production staff could improve revenue generation by at least 15%.
Determining the Income
- Based on the given figures, we can now derive the amount of our income by extracting the difference between 2008 and 2009 costs, via this equation: $250,000 - $175,000 = $75,000. This would be the amount saved by the company from reducing the costs incurred by the HR unit in its hiring process.
- In addition, management projected that for every unit of manpower added, the company could increase its revenue by at least 15%; hence we can compute for this additional benefit by way of this mathematical statement: $ 75,000 x 15% x 30 employees = $337,500
- Add the increase of $337,500 to the savings of $75,000 generated from cost-cutting measures, the total income attributed to the new hires for 2009 was $412,500.
- However, the direct costs of $215,000 for hiring 30 additional personnel was deducted from the total income to arrive at the net income. The equation would be $412,500 – $215,000 = $197,500.
- The Net Income contribution of HR’s new hires is equivalent to = $ 197,500
To compute the ROI for hiring employees, we will use our net income and asset investment values using the traditional ROI formula:
ROI = $ 197,500 (Net Income) / $ 150,000 (Asset Investment or the Salary of New Hires) x 100
ROI = 131.67%
This means that if all considerations used in this computation are met, wherein management’s scenario does not provide for any possibilities of absenteeism and that new hires will perform according to expectations, every dollar spent in adding 30 employees will ideally contribute a 131.67% return from the additional manpower.
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The Increased Income Method
It was mentioned earlier that for this method, the income used for computing the ROI, will be the increment between the previous year and the current year.
Suppose the company’s income in 2008 is $375,000 and $565,000 in 2009, with the same cost of $150,000 for 30 additional employees, the resulting ROI will be calculated as follows:
Net Income = $565,000 (Income in 2009) - $375,000 (Income in 2008)
Net Income = $190,000
ROI = $190,000 / $150,000 x 100
ROI = 126.67%
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After computing the ROI, you should know how to interpret it according to its relevance to the job recruitment process.
In both methods, the resulting ratios are only benchmark figures since the setting was projected in the most ideal conditions. The Human Resources Department therefore should aim to hire employees who are fit for the job, since there is no room for absenteeism.
Health problems should be a criterion for elimination and the submission of clean bill of health will be an important requirement. Age will also come into the picture since the worker who will assume the job position should have the quality of being robust with great capacity for endurance.
It would also be important for the candidate to have the right attitude towards the job, inasmuch as hundred percent performances are expected from every new unit of the additional workforce.
The salary offer should be competitive and perhaps provide more motivation to excel or surpass performance milestones, so that the company will reap the benefits of gaining more edge over industry competitors.
If you’re aiming to acquire the services of a good worker, then your company should also be a good employer that a good worker would want to work for.
Gender issues should not be a basis, since some female candidates can manifest equal ability to use muscle power and stamina. Consider all factors required by the job, because manpower costs even if not incurred as salary expenses become productivity losses.
However, it should be clear that all these preferences will only be your own guidelines as bases for selection, and in accordance with your right as employer to choose whom you consider as fit for the job. Such preferences should not be expressed or stated in your notices of publications for job posting, since this will qualify as a “discriminatory act". Keep in mind that every citizen enjoys the basic civil right to equality in opportunities.
After all, calculating the ROI for hiring employees is intended as measure for standards of performance and not as basis for discrimination.
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Reference Materials and Credit Section
- What's your ROI on people? --- http://www.allbusiness.com/human-resources/workforce-management-hiring/814057-1.html
- Calculating ROI for Selection --- http://www.ddiworld.com/pdf/ddi_calculating_roi_for_selection_wp.pdf