From Excellence To Economy

by Michael C. Kelly, MA

Introduction

This article demonstrates the investment qualities of training for organizations. It is made up of two viewpoints. The first describes the investment environments where cost benefit analyses are performed. The second maps out a workable cost benefit analysis formula. These views, in turn, come together to establish a foundation for expanding measurements on training investments.

Investment Environments

Calculating any return of a training investment involves the establishment of performance objectives and the preparation of a cost benefit analysis. The analysis component defines the cost of the investment required to achieve a potential cash flow benefit. Actual calculations are prepared using standard accounting methods. But unlike some calculations, say those for money market, interest bearing securities, training cost benefit calculations are not always based on fixed rates of return. For this reason they are often imprecise. Training cost benefit analysis, in short, is not an exact science. It can however, provide an investment perspective based on current training needs and long-term productivity expectations. Ultimately they allow the investor an opportunity to make an informed investment decision on a particular training purchase.

Conducting a cost benefit analysis also requires proper resources. Time is the most valuable resource; sound analytical skills are its servant. The training investor often makes productivity calculations, judges training market trends, and establishes financial goals under last-minute, tactical training conditions. These conditions usually arise from poor planning, sudden changes in technology or unexpected shifts in human resources. They, in turn, create a productivity imperative characterized by a potential and immediate loss of market share or a sudden decline in competitiveness. For this reason, a clear understanding of analysis methods, an ability to prepare and execute training investment strategies and time are needed to ensure productive continuity and competitiveness. The time spent preparing the analysis, if too long, can negatively affect investment outcomes.

Another important resource is organizational information. This information closely relates to the particular training investment being addressed and consists of all the quantifiable, productivity values that make up a performance discrepancy. These may include the cost of production, volume of sales, expected instructional disbursements, lost wages, course development expenditures and price of lost productivity. By quantifying these values other, larger corporate financial perspectives fall into place.

Given these resources, the training investor looks at how best to approach the analysis. This is done by establishing performance discrepancies, usually through a needs assessment, and isolating training investment costs. This process, in turn, isolates costs or revenue benefits and targets appropriate training solutions. One of four training investment environments, from which cost benefit analyses are conducted, emerges from this process.

... Benefit Types

The four environments are a hybrid of two benefit types and two training solutions. The first benefit is cost-motivated, where the result of a training experience cuts costs. Training staff to operate a computerized accounting system, for example, could reduce the time required to prepare financial reports. This time savings, expressed at an equivalent salary rate, is reallocated to maximize staff productivity by paying wages that generate greater outputs. The staff could then prepare demand financial reports and use the saved time to manage accounts receivables. An ability to manage accounts receivables, in turn serves to reduce credit carrying costs.

Revenue-motivated training, the second type, results in an increase of revenues. The above example touches on a revenue motivation. By reducing accounts receivables, client collection periods are shortened, which improves the cash position and allows investment or debt servicing.

Other revenue motivations reflect entrepreneurial ventures where an add-on service is designed to generate new revenues. A firm introducing desktop publishing services, for example, may require training on their computer systems before a quality product can be delivered. Various training environments often overlap to meet cost savings and revenue generation expectations. Both address performance discrepancies but realize the benefits in different manners. These benefits, added together, reflect a net performance improvement. Computer-related training, as we have seen, can look to reduce time spent performing manual functions (costs) and redirect this time to produce new goods or services (revenues).


Fig 1: Investment Environments

... Solution Types

The first solution type, hard training, is applied. It involves mental or physical activities and produces direct, easily measured results. An individual, for example, who learns to drive a car in a forty-hour course, including classroom and practical training, is usually able to turn the car on, put it in gear, accelerate and stop immediately after the course is completed. The degree to which they are able to do this is easily measured through observation.

The second solution type, soft training, is conceptual, cognitive and results in a potential for action. This type is more difficult to measure since the results are not always immediate. If, for example, a sales person takes motivational sales training, they may be motivated at the end of the course to set a personal goal of doubling their sales in the next year. The achievement of that goal will not be evident immediately after the course is completed. Also, with time, the trainee may become disillusioned, perhaps because of declining sales due to market conditions or poor office relations. The return on the original training investment, in this case, depreciates with time, perhaps to the point where training requires repeating. This condition creates the greatest anxiety with training investors and constitutes a greater risk.

Each of the benefit types and training solutions constitute four basic cost benefit environments. Arriving at one involves the use of coaching techniques that focus on organizational or community issues. If, for example, a manager discovers a work environment replete with grievances, work stoppages and high absenteeism, there may be a need for management training (soft). If products take too long to produce and additional staff are required, then hard training on the production line might be in order. In the first example the training type is soft (managerial) and cost-motivated. The second example is based on hard training (production line operations) and the benefits are cost motivated.

Perhaps an organization envisions an increase in sales of $1,000,000 annually - perhaps as identified in a business plan. Sales staff, however, are skeptical of the goal and unwilling to meet it. A sales motivation training solution (soft) would be revenue motivated in this case. Finally, another business may identify a potential revenue increase of $100,000 through additional desk-top publishing services. Though the computer system is in place to address this service, staff may not know how to use it. A desk top publishing training solution (hard) would be revenue-motivated.

Arriving at these environments requires an understanding of relevant productivity issues, sharp analytical skills and an ability to establish good working relationships with key organizational players. Probing questions that emerge from the analysis focus on specific, quantifiable productivity issues. Focusing on the specific, rather than the organizational, has a bottom up effect. Cash flow improvements generated from one training activity ultimately impact on the overall cash position. The size of an organization, the nature of a performance discrepancy and the scope of the investment dictate the degree of impact.

Focusing on the specific, for larger organizations, can be easily accommodated though training circles measure performance discrepancies, prepare cost benefit analyses and gauge investment returns at the department level. Each training investment is monitored to maintain or improve operating efficiency.

Applying cost benefit analysis to specific productivity issues enables the training investor to isolate improvements, monitor sources of increased cash flow and associate certain returns with particular training types. They became, in short, wise consumers of training.


... The Formula

After establishing training investment environments and qualifying values, the relevant data in harvested to complete the cost benefit analysis. Though this information is collected and articulated in the training plan, it is presented in a simple cost benefit formula. The formula is stated in the diagram below:


Fig 2: Cash Flow Benefit

A potential cash flow benefit is defined as an increase in revenue generation or decrease in costs. These increases or decreases, however, are not always readily observable on a bank statement. Two hours saved by an organization utilizing a computer system, for example, is often reallocated for some other, more productive function.


Points A, B and C of the formula address performance discrepancies; C, an absolute number, is the gross discrepancy. If A, in a cost motivated example, is $1,000 and B is $500, then C reflects a potential cash flow benefit (gross difference) of $500. Where A, reflecting a revenue motivation, is $500 and B is $1,000, then C reflects a potential cash flow benefit (gross difference) of $500. These benefits are annualized in the formula, allowing easy integration with other financial reporting systems.

Points D, E, F and G reflect the value of the investment needed to realize a net, potential cash flow return. D reflects all direct instructional costs, including:

  • hourly, fee or contract charges
  • supply and material costs
  • rental facilities, equipment and materials
  • travel costs for trainees or instructors
  • accommodation costs for trainees or instructors
  • meals charges
  • miscellaneous costs

Point E includes the cost of development in course materials, such as:

  • written materials ( text, workbooks, etc.)
  • presentation materials for audio visual or overhead projectors
  • simulations
  • tutorials
  • questionnaires
  • computer-based learning tools

Point F includes the lost wages consisting of;

  • wages paid to staff while training
  • wages paid at overtime rates to staff training after hours
  • time off - calculated at vacation pay rates - taken in lieu of pay

Point G is calculated by including the:

  • cost of running parallel systems, say a manual and a computerized accounting system
  • cost of hiring replacement staff while training
  • cost of not producing

Point H totals the value of the training investment.

Though point I reflects the net cash flow benefit, the gross cash flow benefit (C) and investment values (H) in this formula serve to isolate training benefits and investment costs. Each can be addressed and altered to reflect the ability to deliver training. Adjustments are made before training commences to

  • consider those cash needs that do not impede other, more urgent operating transactions
  • assess cash availability for emergency use
  • maintain an ability to take advantage of specific opportunities
  • address credit standings with short-term lenders or suppliers

If, for example, lost wages are too high for immediate cash flow needs, the number of trainees may be reduced. The goal, in other words, is to weigh training benefits and investment costs in a way that not only addresses productivity, but respects an organization’s immediate cash flow position.

Once these benefits and costs are established, the investor can calculate a pay back period. To calculate pay back period, divide the total investment cost (H) by the gross benefit (C). In other words:


Calculating pay back periods serves two purposes. First, it estimates the time required to recoup the original investment costs. Second, it acts as a bench mark from which to conduct training evaluations. Based on the bench mark, approximately six months after the pay back period, an evaluation can be conducted to measure the benefits in progress and, if necessary, recommend remedial action. Training investments with long payback periods may require periodic progress evaluations to keep investments on track. If these evaluations differ from projections, then terminal performance objectives, cost benefits and pay back periods will require adjustment.

Since all figures are annualized, they can be used to project productivity and cash flow improvements two or three years later. This may be of use to human resource planners looking to assess the value of their training staff at some future state. This exercise, however, should be conducted to give the planner a sense of the long-term benefits. The projection, by necessity, considers work environment, technology and staff changes.

Once the projection is completed, the entire training plan, with its cost benefit analysis, becomes a tool for further analysis. From a return on investment perspective, the investor can make on informed investment decision. Also, some investments, though they look good at the outset, go bad in midstream.

The investor, with the training plan as a guide, can determine when to stop a training investment. If training costs, course development expenditures, lost wages or lost productivity exceed estimates and cripple the benefits, the investor can halt training. Finally, when training in completed, the training plan, with its pay back period, becomes the tool for evaluating performance and financial results. The investor evaluates the return be readdressing the cost benefit analysis formula. Does the value of the discrepancy change? What were the actual instructional, lost wage and lost productivity costs? Each of these figures should be noted in an evaluation and measured against the original forecast.

Conclusion

The merits of measuring returns on training investments and, more specifically, performing cost benefit analyses are widely debated throughout many training and consulting offices. Some see it as necessary for survival. Others dismiss the exercise as something unrelated to the true art of training.

Training cost benefit analysis, regardless of its position on the survival-art continuum, is a component of business management. It serves to complete the planning process, establish training track records and allow organizations to develop the holistic perspectives needed to make investment decisions.


© Michael Kelly, 1989

© migashco, 1995 (reprinted here with permission)


© 2011  Michael C Kelly