Running a sustainable, scalable business calls for smart HR planning that has as little impact on your gross revenue as possible. While you want to ensure your team can manage the workload efficiently to remain productive, understanding the payroll-to-revenue ratio is critical for financial executives responsible for profitability. Here, we look at how to calculate and optimize your payroll-to-revenue ratio with tips to reduce payroll impact on your bottom line.
Payroll as a percentage of revenue is a financial metric that measures how much of your company’s revenue goes towards employee wages and benefits. It is critical to labor cost assessment and understanding how labor costs impact profitability. The ratio is measured based on your industry and organization size and calculated based on the following formula:
(Total Payroll Expenses / Total Revenue) x 100
Although seeing a high ratio might be discouraging, you must measure your ratio against industry benchmarks.
This isn’t a number you can pinpoint in general terms. Too many factors affect the ideal payroll-to-revenue ratio, including industry standards, company size, and business objectives. However, payroll as a percentage of revenue should range between 15% and 30%. Anything above 30% typically means your labor costs are starting to eat into your earnings, and you are not effectively controlling labor costs.
However, labor-intensive service-based businesses can reach payroll costs of up to 50% and maintain profitability. For example, industries such as healthcare, hospitality, and manufacturing tend to have higher labor intensity. Keeping an eye on this important metric allows you to set an ideal payroll percentage to meet your business goals and make adjustments that keep your labor costs at scale with growth.
When calculating payroll, you require the following documents to ensure accuracy:
Add up the following expenses to calculate your total payroll:
Tally your revenue using the following records to find your gross revenue, which excludes any charges collected without markups, such as sales taxes, freight charges, etc.:
It’s important to compare your document sources to confirm the numbers are accurate before calculating the totals to find your ratio.
Here are some example calculations:
Example 1
A retail company has a total payroll of $1,000,000 and revenue of $5,000,000 which is calculated as ($1,000,000 / $5,000,000) x 100 = 20%. This tells you the company allots 20% of revenue to labor costs, which is within the average safe levels, but at the higher end for the retail industry.
Example 2
A beauty salon has $400,000 in gross revenue and $120,000 in total payroll costs, which is calculated as ($120,000/$400,000) x 100 = 30%. In this case, the company allots 30% of revenue to labor costs. Compared to industry benchmarks this is a healthy ratio.
The payroll-to-revenue ratio allows you to evaluate how efficiently you manage your labor costs, how labor-intensive your business has become compared to industry benchmarks, and the impact payroll expenses have on your profitability. As a result, you can inform your labor decisions and gain better control of cost management in relation to payroll expenses.
Since these numbers vary greatly by industry, it’s important to consider industry benchmarks to put your ratio in context. Here are some typical industry payroll percentages:
Industries such as healthcare, hospitality, and services such as hair salons tend to have higher labor intensity because they require more physical effort to complete processes. As a result, their labor costs outweigh capital costs. Less labor intensive industries such as pipeline transportation, real estate, or auto repair rely on less labor, with fewer people required to complete business tasks and processes.
There are three key strategies that can help reduce payroll percentage:
Workflow optimization solutions find efficiencies while helping you understand business workflows through reporting and analytics. This allows you to effectively scale your team using automation for time-consuming lower value tasks. You can also identify scheduling inefficiencies through effective time tracking and metrics to plan labor needs based on trends. It also allows you to streamline the following labor-intense processes:
Planning ensures talent is managed effectively to improve productivity. Providing your HR team with the tools needed to identify key talent, create a proactive talent pipeline, and track talent throughout their career lifetime ensures you are leveraging skills and empowering employees to achieve their goals.
These strategies help boost both productivity and retention, reducing labor and high turnover costs. You can also use workforce management software to measure performance and use metrics to identify expenses related to overtime, skills gaps and productivity to overcome team inefficiency.
Considering options such as outsourcing non-core functions or hiring contract labor can also help control payroll costs. In fact, this is an excellent way to contend with ongoing fluctuations filling skills gaps based on demand. Outsourcing and contracting has become an important factor in effective HR planning, providing temporary talent to avoid unplanned payroll costs.
As a finance executive it is critical to assess the payroll-to-revenue ratio to find opportunities to optimize efficiency and profitability. Through ongoing monitoring, you can continue to improve performance with adjustments to maintain a healthy balance between payroll expenses and revenue.
Paypro’s payroll automation solutions provide essential analytics of your payroll costs and employee time utilization ratios to make effective decisions for workforce management and budgeting. Learn more or to set up a free consultation with our payroll experts today.