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What Small Businesses Need to Know About Labor Costs

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Payroll is expensive, perhaps more so than the average small business owner realizes. Depending upon the industry, wages and associated compensation paid to employees range from 10 percent to 30 percent of revenue. That’s a chunk. It’s imperative that entrepreneurs understand exactly both the obvious and hidden costs of maintaining a staff of workers. The trick is to find that fine balance of exactly enough employees to maximize profit while not having people standing around looking for things to do. Every small business owner needs a baseline knowledge of labor costs. This understanding could be a contributing factor to success or failure.

Know Your Industry

Labor cost as a percentage of revenue vary wildly among business sectors. The manufacturing industry tends to have a lower percentage of labor costs than industries like restaurants, theme parks, or brick and mortar retailers. Trucking carries the highest costs of all at close to 60 percent of total cost.

The first thing to do is figure out what the standard is for your industry and see where your payroll falls on the spectrum. If you’re out of whack to either side make it a point to figure out why. High costs need to be reigned in. Even if  your labor costs come in low, you still need to figure out what you’re doing and make sure you keep doing it.

Know the Math

Any small business owner with a basic calculator can figure out what her labor costs are by percentage. If you had a gross revenue to $500,000 last year and spent $100,000 on payroll. Divide the revenue number by the payroll number and convert the result to a percentage. In this example you would come up with .2 which is equal to 20 percent. Keep in mind this calculation is only as valuable as the accuracy of the numbers in the equation. That means you need to total up all expenses associated with your employees and not just the obvious expense of wages. Keeping good records makes this easier.

Base Pay Plus…

Base pay is an easy number to figure out, but it’s the other expenditures that can drive the cost of an employee up to 40 percent higher. When you calculate labor costs, don’t forget to include health insurance premiums, uniforms, overtime, federal and state taxes, workman’s compensation, paid time off, and time spent training a new employee. Once you crunch all these sometimes forgotten costs, you’ll find that an employee you pay $14 an hour actually costs you close to $20. This can be a shock to the system of a small business owner who has never taken the time to add it all up.

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