Are you spending too much of your company’s hard-earned revenue on payroll expenses? You can use the payroll-to-revenue ratio to find out.
The payroll-to-revenue ratio can help you gauge efficiency and profitability for improved decision-making. Read on for the formula, steps to calculate it, and more.
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What is a payroll-to-revenue ratio, and why does it matter?
The payroll-to-revenue ratio measures how much of your business revenue you spend on payroll expenses, like wages and benefits, during a period (e.g., month, year, etc.).
The ratio may go by several names, including:
- Payroll percentage of revenue
- Payroll expense ratio
- Labor cost percentage
- Employee labor percentage
You can use your payroll percentage of revenue to determine efficiency, budgeting, and payroll forecasting. Knowing your ratio can help you make decisions about scheduling or hiring.
Payroll-to-revenue ratio formula
Use the following formula to calculate how much of your revenue goes to payroll expenses:
Payroll-to-Revenue Ratio = (Total Payroll Expenses / Gross Revenue) X 100
Your total payroll expenses include:
- Salaries and wages
- Employer’s share of payroll taxes (e.g., Social Security tax)
- Employee benefits (e.g., health insurance, 401(k) employer contributions, etc.)
- Commissions and bonuses
- Overtime pay
- Expense reimbursements
Your gross revenue is your business’s total revenue—including sales and other income—during the same period as the payroll expenses.
Let’s say your total payroll expenses last month were $100,000 and your gross income was $500,000. Your payroll-to-revenue ratio would be 20%:
($100,000 / $500,000) X 100 = 20%
How to calculate your labor cost percentage
Use the following steps to calculate your payroll percentage of revenue:
- Add up your total payroll expenses
Calculate your total payroll expenses during the period, including salaries and wages, benefits, payroll taxes, and other costs you paid.
You should be able to find all of this information laid out in your payroll software reports, if applicable.
Example: Your total payroll expenses are $10,000. - Determine gross revenue
Calculate your business’s total gross revenue during the same period. You can find this at the top of your income statement, which your accounting software can automatically generate for you.
Example: Your total gross revenue is $30,000. - Use the payroll-to-revenue ratio formula
Divide your total payroll expenses by revenue, and multiply the total by 100 to get your payroll-to-revenue ratio.
Example: ($10,000 payroll expenses / $30,000 gross revenue) X 100 = 30%
What percentage of revenue should go to payroll?
The higher your payroll-to-revenue ratio, the more money you spend on payroll costs compared to business sales, which may indicate inefficiency.
The lower your payroll-to-revenue ratio, the less money you spend on payroll costs compared to business sales, which can indicate efficiency and profitability.
Many businesses aim for a payroll-to-revenue ratio of 15% – 30% as a general rule of thumb. However, this isn’t a one-size-fits-all number.
Payroll-to-revenue ratio by industry can vary significantly. Some industries, particularly labor-intensive fields, require more employees to operate and drive revenue. For example, a “good” ratio for the restaurant industry might be 25% – 40%.
How to reduce your payroll-to-revenue ratio
Is your payroll as a percentage of revenue too high? Reducing your payroll-to-revenue ratio can improve profitability and efficiency.
You can use the following tips to get started:
- Increase revenue: You can drive up sales by offering discounts, adjusting pricing, adding new products/services, and upselling and cross-selling.
- Improve efficiency: By automating tasks, streamlining operations, and cross-training employees, you can boost efficiency and avoid overhiring.
- Use payroll software: Payroll costs typically include administration, aka the cost of running payroll. Use payroll software to save time and money—and lower your payroll-to-revenue ratio.
- Cut back on overtime: Time and a half pay adds up. By improving efficiency, you can reduce your company’s need for employees to work extra hours.
Remember that your industry’s ratio may be naturally higher than the 15% – 30% average (and that’s OK!). But if you’re ready to reduce your ratio, there are ways to cut back without laying off employees.
This is not intended as legal advice; for more information, please click here.
