What percent of your revenue should be allocated to payroll?
Deciding how much of your bottom line to dedicate to employee salaries is a critical consideration to make. Payroll is frequently one of the most significant expenditures for a business owner. Not only is payroll a regularly occurring expenditure, but it also comes with strings attached: taxes, insurance, and additional add-ons like vacation time, sick days or credits. For managers trying to hold on to already-slim margins, payroll can feel like the Achilles’ heel that can make or break a business operation.
Unfortunately, there is no one magic payroll number that can be applied to every business. However, taking your degree of profitability into account along with other business functions can aid you in determining a reasonable ratio of payroll to revenue. Service businesses, in which typical manufacturing is replaced with sheer manpower, can take on higher payroll percentages since the payroll is, in fact, the product.
Your employees productivity is the most important number of all and is the amount of production your employees give the business per hour, measured by the output divided by employee cost, and is a huge variable that can be significantly influenced by management efforts.
In order to determine whether you are currently on the right path or if you may be setting your business up for trouble, examine the ratio of your payroll expenses to gross revenue.
Once you have compared these two numbers, look at payroll as a percentage of gross revenue. If your payroll expenditures fall within 15-30% of gross revenue, your business is in a safety zone of sorts with solid footing. Businesses that live within this range tend to be most successful, at least from a payroll perspective. However, there are many businesses, usually within the service industry, who operate with payroll making up more than 50% of their gross revenue.
Too many business owners fail to include themselves in the payroll equation, and therefore come out anticipating payroll numbers that are deceivingly low. Regardless of whether owners take a traditional paycheck or qualify their income as “owners draw” it should be included in any payroll calculations to provide an accurate picture of finances.
Knowing your business’s ratio of payroll to revenue is only the first step in solidifying your business assets, however. The larger issue is choosing to do something about that ratio. Too many business owners are clueless when it comes to reducing payroll while maintaining or increasing productivity. Exploiting this potential is the secret to business stress.
There are a number of ways to accomplish this but the point of this post is to learn how to identify the red zone, after 30% and then to figure out what to do about it if it is higher. First take a hard look at your actual payroll costs, the real costs, which include not only staff salaries but also the “extras” previously mentioned like insurance and taxes. Be sure to also calculate your own earnings accurately, and then compare this tally against your gross revenue. If your percentage falls above 30%, in the red zone, it’s time to come up with a new strategy immediately. Maintaining a payroll that falls above 30% of your gross revenue is one of the most common reasons for a business to fail.
Identify first and then fix…take the test today and then call me for help I can help you fix this issue, easily, quickly and safely.
To learn more about our debt workout strategy, and how it can handle IRS payroll tax concerns, please speak with our team.