Defining and understanding your Cash Flow &  Profit Margin objectives are more important than ever.

• In a prior article we discussed metrics regarding Sales per Employee and how to analyze this trend. This article addresses the second metric,

Payroll to Revenue ratio, 

…  a productivity metric that measures how effective a business is at utilizing its labor costs to produce revenue.

How to calculate Payroll to Revenue ratio:

Total Employee Costs/ Gross Revenues from Sales

Step 1:  Calculate all the wages paid to employees during the period (month, quarter, year), including overtime, bonuses, and other incentives. In addition, calculate your expenses for payroll taxes, which includes Social Security and Medicare. Add in unemployment insurance and any travel expenses paid to salespeople. Include all Owner’s distributions, bonuses, salaries, benefits, and other form of consideration.  You must include all employees, owners, and stockholder expenses (excluding dividends) so the Employee cost number is not distorted.

Step 2:  Calculate your Revenues during the same period (month, quarter, year). Like Sales by Employee, exclude income gained from the sale of property or other assets, and remove any income derived from interest on investments.

Step 3: Divide Total Employee Costs/ Revenues from Sales

How to interpret the ratio:

We suggest you track the ratio monthly and compare to the Last Twelve Months (“LTM”) , also referred to as Trailing Twelve Months (“TTM”) as detailed in our article, Avoid Employee Longevity being a Profit Problem!    What is crucial is tracking the trend to alert you to changes.

Standard industry data suggests a payroll-to-revenues range of 20 to 30 percent tend to do well for a service industry.  Heavily labor oriented businesses will have a higher ratio.

Payroll costs and sales revenue usually move in the same direction, so the ratio ideally should remain somewhat consistent as the business grows. If the ratio drop’s too low, it may lead to a non-sustainable work level for your employees and leading to a declining level of customer support for customers.  Conversely, if the ratio is rising, productivity may be declining, or employees may not have sufficient work.

We hope you found this useful.

Companies post “This is a great place to work” and brag about their employees’ longevity.   More times than not,

EMPLOYEE LONGEVITY IS THE GREATEST PROFIT KILLER FOR SMALL & MID-SIZE BUSINESSES!

Why?  Simple example-  Employees have come to expect annual Cost of Living wage increases. Over a period of 3-4 years these increases may eclipse efficiency gains from that employee. Think how much it costs the business over 5, 10, 15 years.

SOLUTION:   make time to track this one metric monthly (see example below):

Sales per Employee

When Sales per Employee increases, your margins are growing, when it decreases your margins are shrinking.

 What is Sales per Employee:  Total Sales divided by number of Equivalent Full-time Employees.  It’s an analytical measure of how productively a company is able to utilize its employees to contribute to its business growth. Technology companies generally have higher ratios that Labor-intensive companies. Therefore the ratios are most useful when compared to the performance of companies within an industry.

Major restructuring and large staff reductions as we have seen with the pandemic will significantly impact the ratio temporarily, so it must be viewed over the longer term.

The ideal is to create an environment where sales-per-employee steadily rises. It’s not as difficult as it sounds, we have helped numerous companies find consistent ways to improve.

A company that consistently generates rising sales with a stable or shrinking workforce can usually boost profits more rapidly than one that can’t make additional sales without adding more workers.