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.