Do Homework to See How Labor Costs Measure Up

What are your labor costs? It’s an excellent question for any business owner, and one that should be asked on a regular basis. This number also should be tracked over time to understand trends and inform you when corrective action needs to be taken.
As your company grew, you probably added staffers to perform specific tasks — naturally. When you started, you might have had a one-person office that answered the telephone, kept the books, did the correspondence, billing, etc. As you grew, you may now have a bookkeeper, receptionist and a customer service representative. The same increase is likely on a manufacturer’s production floor or a retailer’s sales floor or a service company’s staffing patterns. And, on the surface that makes sense. Where once you had five employees supporting $50,000 in sales, you might have 50 staffers handling $3 million.
But a true test of your productivity is the percentage of the cost of sales that your labor requires. On a direct basis — the actual cost to produce or provide your service/product — the number should remain about even, and go down as you gain efficiencies with increased size. Restaurants, for example, often have labor costs that run around 30 percent. Service businesses, on the other hand might exceed 40 percent.
After your best cost level has been established, you need to make sure you keep within your goal. If you don’t know the average for your business, check with your industry association. If you have historical records, compare your actual costs with industry averages.
You would then compare your cost of labor to your revenues. For example, if the 5 employees cost you $12,000 supporting $50,000 in sales you have a 24 percent cost of labor to sales (12/50). But then you added full-time staff, managers, production, sales help, etc., for a total of 50 employees for total payroll of $1.2 million to support the $3 million in sales. Your cost of labor to sales has risen to 40 percent (12/30). That increase from 24 percent to 40 percent is the area that should be analyzed. There may be good reasons for it, but the key thing is that you know and understand the facts and the reasons behind them.
The raw numbers can be misleading or masking a management decision that needs to be explored. We need to be comparing percentage of increase (or decrease) of expenses to sales and personnel expense is a critical area for small businesses to consider. If you decide that you must “retrench,” be sure that you are working with all the facts.
Marcia Bagnall is Director of the Chemeketa Small Business Development Center and instructor of Small Business Management Program . The Small-Business Adviser column is produced by the center and appears each Sunday. Questions can be submitted to SBDC@chemeketa.edu. Visit the SBDC at 626 High St. NE. in downtown Salem or call (503) 399-5088.

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