Human Capital as Key Factor for Business Success. The Importance of Human Capital


Academic Paper, 2018

20 Pages, Grade: 1,0


Excerpt


Table of Contents:

1. Index of abbreviations

2. List of tables

3. List of formulas

4. Introduction
4.1 Statement of the research question
4.2 Ambition and approach

5. Definition and differentiation

6. Evaluating human capital
6.1 Methods to evaluate human capital
6.2 Case study part one: Evaluating human capital at ITL

7. The impact of Human Capital on business success
7.1 Case study part two: The impact of human capital at ITL
7.2 The impact of human capital on business success in general

8. Analysis and discussion

9. Conclusion and outlook

10. Bibliography

1. Index of abbreviations

International Accounting Standards Committee IASC

International Accounting Standards IAS

Human Capital HC

Infosys Technology Limited ITL

Organisation for Economic Co-operation and Development OECD

2. List of figures

Figure 1: Individual investments in human capital

Figure 2: Analysis of human capital accounting of ITL

3. List of formulas

Formula 1: Calculation of the human capital value

Abstract:

This paper examines the questions of how important human capital is for business success. With this intention it is first defined what human capital is before there are evaluated several measurement approaches concerning the valuation of human capital in a company. Consequently, embedded into a case study, the value of this asset is calculated with the Lev & Schwartz model at an Indian tech company called Infosys technology limited. As a result of the case study it is pictured that human capital and the returns of Infosys are highly correlated, which underlines the hypothesis that human capital is a key factor for business success. To generalise the stated findings there is also a view on a macro economical level. The main result of this paper is that human capital actually can be said to be the most important aspect for business success. In a last part the author criticises that many companies do not pay enough attention at human capital.

4. Introduction

4.1 Statement of the research question

Modern economies have changed from agricultural to industrial to service- and techno-logy based economic systems.1 As a result the intangible assets of a company can be more and more identified as the key value drivers for business success. Tangible assets on the other hand diminished in value and have lost importance as success drivers. These circumstances manifest themselves in numerous companies as a value gap between market value and, in comparison to this, low reported equity.2 Besides brand value, customer relations or patents the high amount of intangible assets is mainly reasoned by Human Capital (Human Capital = HC).3 Due to its importance for economic success and social development the HC has become to a prioritised topic among science during the last century.4 According to Stewart (1998) the HC of a company will even be the only factor of production that can be further developed and is able to increase a companies value in the future.5 Therefore HC can also be described as a key driver for competitive advantage.

Stated the fact that the impact of HC is gaining importance and is becoming more and more crucial for business success, it should be easy to claim that companies should invest in this asset without any doubts. However, this statement is not that easy to prove. This is reasoned in the fact that the impact of HC actually is not that simple to measure, simply because it is an intangible asset. This problem is not only relevant for the valuation of a company, it is also a problem concerning the question if investments in HC actually pay off. Needless to say, companies need evidence concerning the profitability of their investments. Therefore the question we are facing is not only if HC really is a key factor for business success, previously there has to be a consideration about how to measure the worth of HC and mainly how big the impact it concerning business success actually is.

4.2 Approach and ambition

To prove HC as a key factor for business success a step-by-step procedure is needed. First of all it should be determined a common comprehension of HC. Therefore there will be some definitions and a differentiation of the topic in chapter four. To measure the actual impact of HC there is a demand for methods to quantify the worth of HC. Hence, there will be some selected methods of measuring it in chapter five. As a next step the impact of HC is clarified theoretically and practically in chapter six. Of course it will be necessary to discuss and analyse the results in a further step, before coming to a conclusion and an outlook.

In this paper there is also included some practical work in the form of a student consulting project. To be more precise, the measurement and the actual impact are pictured theoretically but also practically at a company example.

The ambition of this paper is to first work out an answer to the question how to measure HC, which will be shown at an example, but mainly to find evidence to the statement, that Human Capital is a key factor for business success.

5. Definition and differentiation

Despite the author already mentioned the term “Human Capital” several times in this essay, yet it is not clear what exactly is intended with this word. HC is a comparatively young field of research, which is why there is no general accepted definition for the term until today.

Edvinson defines HC as a consumption of all human resources of a company, which are available to produce goods or services.6 Thus it constitutes all the individual abilities, skills and experiences of the employees and managers. Besides this also creativity and innovative strength can be seen as a part of HC. The term therefore refers to the whole intellectual and physical capacities, which are either latent available or already used.

Some contemporary growth theories in economic science see HC as an important factor for economic growth. Already Adam Smith emphasises the importance of education for the economic walfare of people. He described the nature of HC as follows: “The improved dexterity of a workman may be considered in the same light as a machine or instrument of trade which facilitates and abridges labour, and which, though it costs a certain expense, repays that expense with a profit.”7 This definition makes another factor about HC clear: it´s got an investment character. Both, human and physical capital can be used to produce goods, though there is a competition concerning their recourse distribution.8

Concerning the differentiation of HC but also to understand the investment character is important to have a look on it from two perspectives: An individual and an entrepreneurial view. Having a look on the individual perspective first there are several aspects to consider: HC is directly linked with a human individual. Hence, there this intangible asset has got limited lifetime. Moreover, in contrast to general knowledge, individual HC is only available and useable when it is offered by the individual mostly against payment. Every person has got a specific HC stock at a time, thereby it is his or her decision to apply this stock.9 According to Becker, the two main HC determinants are school and university education and vocational trainings during professional activity.10

Having a look at the entrepreneurial perspective of HC it is necessary to define the term asset in general first. According to the International Accounting Standards Committee (IASC), „[a]n asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise”11 Thus for a company the benefit profile of assets are based on their direct or indirect future inflow of means of payment.12 Basing on this definition of an asset, could HC also be clarified as an asset, which would include an activation and therefore an increasing goodwill of a company? On the one hand the human performance potential would indeed mirror the for an activation of an asset necessary future inflow of means of payment, but on the other hand the authority to dispose the asset, which is the second key factor to declare something as an asset of a company, is only partly given. The relation between HC and a companies authority to dispose it is, if at all, rather rent-like. A third aspect which basically argues against the declaration of human capital as an asset is the already mentioned fact, that there is a lack of reliable financial evaluation approaches.13 To put it in a nutshell: According to the IAS, the declaration of HC as an asset must be seen critically. But critically is furthermore the fact that in order to increase the goodwill, enterprises could raise the value of their HC stock by investing in training courses. This includes the possibility of self-developed intangible assets.14

Consequently to the given information about the nature of HC, in the following investigations human capital will be understood as not in return of payment acquirable, intangible asset, which can be partly affected or rather partly be self-developed by a company.

6. Evaluating Human Capital

6.1 Methods to evaluate human capital

Despite the increasing importance of intangible assets until today there hasn´t been enforced a general accepted approach to evaluate intangible assets. According to the International Accounting Standards (IAS) there are four methods to evaluate an asset in general: The evaluation on the basis of the historical acquisition costs; the replacement costs; the disposal value or the net present value.15 These methods can be distinguished in three main evaluation approaches: Cost-oriented methods; future-oriented methods and market-oriented methods.

The evaluation on the basis of the historical acquisition or production costs and the replacement cost method can be assigned to the cost-oriented evaluation approaches. Historical acquisition or production costs are the costs that had been necessary to acquire or produce a determined good. In the case of HC these costs include requirement costs or the costs of educating new employees. The replacement costs in the manner of HC are represented by the composed costs which would be necessary to replace the whole employee base.16 Evaluation methods which are basing on historical acquisition costs do fulfil most of the required criteria for measurement methods such as objectivity, consistency and reliability, but the acceptance criteria is in this case only insufficiently fulfilled.17

The method of the net present value is a future-oriented method. This one but also similar future-oriented methods contain two main factors: expected future cash flows and the capitalization interest rate. Hereby, the challenge is to determine forecasts about expected cash flows. The capitalization interest rate represents the return expectations of alternative investments with equal risk. Future oriented methods in general are widely accepted but they completely rely on the expected forecasts which results in a limitation concerning objectivity, reliability and practicableness.

Market oriented evaluation approaches like the disposal value method are basing on value assessments of market participants. Whereas in general these methods are particular suitable to determine the value of goods, in the case of HC there is the problem, that there aren´t existing functioning markets for this case. Therefore, the application of this method is only possible in exceptions such as transfer areas for professional athletes.18

Investments in HC can be assigned to monetary and non-monetary target figures. Besides quantifiable return indicators, non-monetary targets like personal growth are hard to measure. This is why many evaluation approaches leave this part of HC behind and concentrate on measurable aspects.19 On an individual basis the measurement of HC follows a simple structure: The individual investments into their own HC such as time and costs are compared to the resulting increase in productivity. The aim on the individual perspective is to obtain higher returns in their working time as if those investments would have been refrained.20

Figure 2: Individual investments in human capital

Abbildung in dieser Leseprobe nicht enthalten

Source: Following Cohn, E., Production & Cost Functions in Education, 1990, p. 34

Despite the individual perspective the focus in this essay is on the impact of HC concerning business success, which means that there also is a need for the entrepreneurial perspective of how to evaluate HC. As mentioned above until today there hasn´t been established one generally accepted method to measure intangible assets, especially how to measure HC in a company. In general these methods, namely deductive summarily methods and inductive analytically methods, rely on the evaluation methods of intangible assets which have already been explained above. Deductive summarily methods are only able to detect the existence of intangible assets in a company but include no information about the value of individual intangible asset classes.21 This is why only the inductive analytical methods are of interest for the following case study. Among the inductive analytical methods the most common one is called the Lev and Schwartz method which was published in 1971. The authors described the urgency for a common measurement approach as follows:

“[…] our employees are our most important – our most valuable asset. […] one might ask: where is this human asset on these statements which serve as reports of the firms resources and earnings? What is the value of this most important or most valuable asset? Is it increasing, decreasing, or remaining unchanged?”22

The Lev and Schwartz method is based on an earning profile of a person which is employed in a company. To be more precise, it is meant the income stream of an employee. “A typical earning profile first increases with age, reflecting the capability of human beings to learn […]. As the person ages, productivity declines because of technological obsolescence and health deterioration, a fact expressed by a decrease in the annual earnings.”23 Therefore, under the consideration of discounted future cash flows, the value for a discrete income stream is: Formula 1: Calculation of the human capital value

Abbildung in dieser Leseprobe nicht enthalten

Source: Lev, B., Schwarz, A., Human Capital in Financial Statements, 1971, p. 3

Whereby: Vr = The human capital value of a person r years old, I*(t) = the persons annual earnings up to retirement; r = a discount rate specific to the person; T = retirement age

[...]


1 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 1.

2 Cf. Daum, J. H., Intagible Assets, 2005, p. 17f.

3 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 1.

4 Cf. OECD, Humankapital, 2007, p. 3.

5 Cf. Stewart, T.A.,Intelectual Capital, 1998, p.65ff.

6 Cf. Edvinsson, L., Brünig, G., Wissenskapital, 2000, p.28.

7 Smith, A., An Inquiry into the nature and causes of the wealth of nations, 1776, p. 16.

8 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003,p. 38.

9 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 37f.

10 Cf. Becker, G. S., Fertility Choice in a Model of Economic Growth, 1989, p. 17.

11 IAS-Framework, Par. 49.

12 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 47.

13 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 49.

14 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 52.

15 Cf. IAS-Framework, Par. 100.

16 Cf. Friedman, A., Lev, B. , A Surrogate Measure for the Firm's Investment in Human Resources, 1974, p. 244.

17 Arthur Andersen (Hrsg.) (1992), S. 30

18 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 59f.

19 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 39.

20 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p. 63.

21 Cf. Persch, P. R., Die Bewertung von Humankapital, 2003, p 91.

22 Lev, B., Schwartz, A., Human Capital in Financial Statements, 1971, p. 1.

23 Lev, B., Schwartz, A., Human Capital in Financial Statements, 1971, p. 2.

Excerpt out of 20 pages

Details

Title
Human Capital as Key Factor for Business Success. The Importance of Human Capital
College
University of Applied Sciences Essen
Grade
1,0
Author
Year
2018
Pages
20
Catalog Number
V988691
ISBN (eBook)
9783346356932
ISBN (Book)
9783346356949
Language
English
Keywords
Human Resources, Business, Human Capital, Humankapital
Quote paper
David Baur (Author), 2018, Human Capital as Key Factor for Business Success. The Importance of Human Capital, Munich, GRIN Verlag, https://www.grin.com/document/988691

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