Book Review: Financial Analysis for Hr. Managers

 

Book Overview

The title of this book is “Financial Analysis for HR Managers: Tools for Linking HR Strategy to Business Strategy”. Its author is Steven Director, a university professor with an MBA and a Ph.D. The contents of the book are meant to equip HR managers with financial skills that are deemed essential in facilitating the linking of the HR strategy and the Business Strategy. The book contains twelve chapters that arranged in a continuous flow that enables the reader to connect the information obtained in an organized manner for better understanding. The chapter titles include Chapter one: the business strategy, financial strategy, and HR strategy. Second Chapter: The income statement. Chapter Three: The balance sheet. Fourth Chapter: Cash flows. Chapter Five: Financial Statements as a window into business strategy. Sixth Chapter: Stocks, Bonds, and weighted average cost of capital. Chapter Seven: Capital budgeting and discounted cash flow analysis. Eighth Chapter: Financial analysis of human resource initiatives. Chapter Nine: Financial analysis of a corporation’s strategic initiatives. Tenth Chapter: Equity-based compensation: Stock and stock options. Chapter Eleven: Financial aspects of pension and retirement programs. Twelfth Chapter: Creating value and rewarding value creation (Director, 2013). These are the contents of this particular book which contain all the financial information that the HR manager requires to know without necessarily having to take further financial studies. The books also consist of sample statements that enable the reader to gain a deeper understanding such as financial statements. Vivid case studies are also given to enable the reader to relate the information gained to real-life situations.

 

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Chapter-by-chapter synopsis of each chapter

Chapter one: Business strategy, financial strategy, and HR strategy

The first chapter of this book is more of an introductory part. It is focused on underlining the importance of a deeper understanding of economics and finance among Human Resource (HR) professionals (Director, 2013). This chapter also attempts to establish a link between three aspects of a business including the business strategy, the HR strategy, and financial strategy. The stand of this book is that for any business to optimize its success, these three strategies must be streamlined. Additionally, the chapter also addresses the process of decision-making among HR managers, where they are encouraged to sharpen their knowledge of finances. The justification for this view is that the largest operating costs of a business are incurred by the HR department; hence a great need to manage such costs (Director, 2013). As the chapter comes to an end, the author makes a final effort to clarify the objective of this particular book. This is followed by a summation of the objective of each and every chapter aimed at informing the reader exactly what they should expect from this book. Thus, this chapter answers the reader’s what? Why? and how? question. What is the book about? Why is the book important to the reader? How is the book structured?

Chapter Two: The Income statement: do we care about more than the bottom line?

This chapter is dedicated to gaining an understanding of an income statement. It also establishes the importance of income statements for HR managers (Director, 2012). To achieve this, the structure of an income statement and its terminologies are explained further though at a basic level. This segment puts an emphasis on the concept of profits in a company, and the role the HR manager can play to influence such profits. Terms related to profits such as EBIT, EBITDA, Gross profits, and pretax profits are put across in this chapter. The reader’s attention is drawn towards operating expenses that can have a major impact on the income statement. Other terms explained include interest expenses, depreciation and amortization, and income taxes. Additionally, the various levels at which profits can be measured are addressed as the chapter concludes.

Chapter Three: The Balance Sheet: If your people are the most important asset, where do they show up on the balance sheet?

In this chapter, the focus is shifted on another kind of financial statement referred to as the balance sheet. The author drives to the point of simplifying the balance sheet as a statement showing what the business owns, and the business owes. A sample balance sheet is provided to provide a deeper understanding of the sheet. The term equity is also explained as being the difference between assets and liabilities. The various types of assets and liabilities are explained to detail (Director, 2012). The questions answered in this segment include: what are current assets such as cash? What are long-term assets such as property and equipment? And other terms such as goodwill are explained. Liabilities including the current and long-term ones are also further explained in order to enable full interpretation of the balance sheet. This is meant to enlighten the HR professional on the financial position of a business.

Chapter Four: Cash flows: Timing is everything

The Fourth chapter is dedicated to cash flows in a business. This is another financial statement which the book considers significant in the sharpening of HR’s financial analysis skills. As explained in this section, the cash flow statement is shown to be closely related to both the income statement and the balance sheet (Director, 2012). The book, therefore, goes ahead to explain how cash flow information is derived from these two statements to come up with a single statement that can be conveniently interpreted by the HR professional. The significance of how cash moves in and out of the business is also explained at length. This knowledge is meant to assist the HR manager in strategizing and in the process of decision making.

Chapter Five: Financial Statements as a window into business strategy

After gaining a good understanding of the various financial statements in the last three chapters, chapter five cements this understanding by connecting the statement to the business strategy. Thus, from this section, the HR manager is able to understand the relationship between the income statement, the balance sheet, the cash flow statement, and the business strategy. A case study is provided in an effort to depict a clear picture of this relationship. A slightly different representation of financial statements called common-sized financial statements is addressed (Director, 2013). As the book explains, this kind of representation enables comparison of statements of different businesses which makes strategizing much easier. The chapter goes on to address the aspect of equity and its relation to the differential impact of financial leverage. With such knowledge of financial statements, the reader is educated on how the HR strategy impacts on the business strategy and vice versa. Thus the bottom line is clear in this case: that the HR manager must familiarize themselves with the financial statements in order to understand the business strategy, and ultimately to come up with an efficient and effective HR strategy.

Chapter Six: Stocks, Bonds, and weighted average cost of capital

This chapter is dedicated to understanding the concept of cost of capital and why this is important to HR managers. The cost of capital is explained at length in terms of exactly what it is and how it factors in the decision-making process of a business. The chapter explains how investments in business and financial allocation decisions rely heavily on the concept of cost of capital. Additionally, decisions to borrow are also based on the cost of capital. Therefore, HR managers require understanding how this process works. Deliberation on this issue introduces new terms including stocks and bonds. These are expounded as sources of finances as well as means of investments for a company. Finally, the weighted average cost of capital is addressed based on whether the source of capital is equity or debt (Director, 2013). The question of how the HR profession can benefit from this information does not go unanswered. Furthermore, the book explains how such a manager can assess the risk situation of the business from the weighted average cost of capital. This is information that is very useful in determining compensation strategies.

Chapter Seven: Capital budgeting and discounted cash flow analysis

Chapter seven explains the time value of money. The question that the reader asks themselves, in this case, is: is the value of a given amount of money the same now as it will be in the future? However, this should not be interpreted in terms of inflation as the book explains. As this is explained, different terminologies come up including present value and future value. Additionally, the book explains that businesses constantly have to study the future value of money in order to strategize effectively. The reader is therefore taught how to calculate both the present and future value and how businesses use such information to make decisions on whether an investment is worth undertaking. The question asked, in this case, is whether the future value can justify undertaking the cost (Director, 2013). The relationship between the time value of money and capital budgeting is exploited thus showing clearly the process. This study introduces the concept of Discounted Cash Flow (DCF) as one of the methods of capital budgeting that is also discussed at length. Given the purpose of this book, the application of capital budgeting in the HR department is not left out. Finally, the chapter concludes with a study of interest rates and how they affect the time value of money.

 

Chapter Eight: Financial analysis of human resource initiatives

After gaining an understanding of the concepts of time value of money and the cost of capital, this chapter’s focus aims at explaining the role that these concepts play in the resource allocation process under the HR department. The occurrence of cash flows is further explained in HR. also, the decisions that are made concerning cash flow are also studied under this chapter. Touching on the concept of cost of capital, the chapter explains the challenges that accompany budget allocation in circumstances where there are many options. The HR profession is thus educated on how they can reach the best decision using these two concepts. Another question answered is: how can the HR calculate the Net Present Value (NPV) of different initiatives? Another issue studied is the impact of a given program. Director (2013) explains that two of the most effective ways to measure program impacts include comparison groups and pre-post changes. Additionally, the chapter focuses on the budget allocation towards HR and questions on whether it is optimal or not. These questions lead to the application of the concepts of cost of capital and time value of money. Finally, the reader is taught how they can maximize the Return on Investment (ROI) while conducting financial analysis.

Chapter Nine: Financial analysis of a corporation’s strategic initiatives

For the HR professional to fully be a partner in business strategizing, then they require the financial skills required to analyze corporations’ strategy. This is the point that chapter nine tries to drive home by educating the reader on the various financial models. The application of spreadsheets in the structuring is taught in this chapter together with methods of estimating the NPV in various strategic initiatives. Additionally, the modeling of risk and uncertainty is addressed in this topic given that risks are a major part of strategizing. The method put forward for the modeling of risk in this book is the Monte Carlo simulation (Director, 2013). This model is explained on how it works and its interpretation of the results giving the HR manager the required skills to a full partner in business strategizing.

 

Chapter Ten: Equity-based compensation: Stock and stock options

Chapter Ten is essentially a study of compensation by various methods. These methods are listed in the chapter as either equity pay or pay by stock options. Thus the basis under which stock options work forms a major subtopic. One of the major questions asked under this topic is: do employees prefer compensation via stock or stock options? And what does that imply for the company? For the HR manager to know this, then this chapter requires them to understand both the intrinsic and time values of an option. The inquiry does not end there as the HR manager is also required to determine whether indeed stock options are high-risk investments (Director, 2013). To achieve all this, the chapter contains a formula referred to as the Black-Scholes model which according to the book is significant for option pricing (Director, 2013). The use of this model is explained at length including its inputs. Furthermore, the chapter also shows how the Monte Carlo simulation can be applied to the valuation of employee stock options. The concepts of overhang and dilution, as well as run rates, are also explained in relation to stock options and their respective relevance to the business. By the end of chapter ten, one is able to gain insight into the practice of equity-based compensation and the impact it has on the importance and most importantly, the role that the HR manager plays in the process.

Chapter Eleven: Financial aspects of pension and retirement programs

This section of the book provides explanations on pensions and retirement programs and the effect that they have on a company especially in terms of profits. At the heart of this explanation are the concepts of Defined Contribution (DC) and Defined Benefit (DB) plans (Director, 2013). Being the most common types of retirement programs, they are addressed at length.  How do they affect the company? Who bears the responsibility, the employer or the employee? How can one shift from DB to DC plans? These are all financial questions that the HR manager ought to ask themselves. Another important financial skill of pension accounting is also explained in this chapter. The chapter further explains issues regarding the selection of appropriate discount rate and the basing of costs on the expected return on plan assets rather than the other option of basing the costs on the actual return on the plan assets (Director, 2013). Through this chapter, the HR manager is able to understand how they can plan and implement the best retirement plans that are fair to the retirees, yet not too straining on the company’s financial resources.

Chapter Twelve: Creating value and rewarding value creation

This is the final chapter of the book and it is a summation of all the concepts described in the previous chapters (Director, 2013). In other words, the question is: how can all these concepts be applied to create value in an organization while at the same time rewarding the efforts of creating value? Thus, in this case, the HR manager is put at task to fully understand their role in a business’ profit-earning capability while at the same time compensating the employees fairly. Thus the financial skill of aligning pay with performance is taught in this chapter at length. At the same time, in the effort of value creation, the way in which the HR manager can manage Earnings-per-share (EPS) expectations is also discussed under this topic.

Summary

As it is understood from the chapter-by-chapter synopsis, this book is primarily designed to equip the HR professional with significant financial analysis skills. I can, therefore, utilize the knowledge learned here conveniently in the HR career. To begin with, the knowledge I gain on income statements will enable me to understand the impact of operating expenses such as compensation on the company’s profits. The information on balance sheets will enable me to understand the financial position of the company which will be very useful information when making decisions. Understanding how cash moves in and out of the business will assisting me in understanding the link between the income statement and the balance sheet. The skills acquired on the interpretation of common size financial statements will enable me to easily compare different statements from different periods or between different companies which will provide me with essential information for strategizing. The Concepts of time value and cost of capital will assist me in functions such as HR budget allocation, calculations of NPV and optimization of the HR budget. The knowledge on models such as the Black-Scholes and the Monte Carlo simulation will enable me to price stock options and determine foreseeable risks respectively. Furthermore, I will be able to align the company’s strategy with HR strategy to maximize profits. Additionally, I will be able to deal with the issue of compensation of the employees effectively having all the facts at my fingertips. Ultimately, I will be able to harmonize the revenue of the business with the compensation in a strategy aimed at maximizing the company’s profits rather than just focusing on employee compensation with no regard for the profits.

References

Director, S. (2013). Financial analysis for HR managers: Tools for linking HR strategy to business strategy. Upper Saddle River, NJ. FT Press.

Director, S. (2012). Financial Analysis for HR Managers: Tools for Linking HR Strategy to Business Strategy. FT Press.

 

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