Every company produces goods or services of some sort that they sell to their customer base with the expectation of making a fair and reasonable profit.
In some industries competitive pressures make it difficult to raise prices sufficiently to cover the increasing cost of materials or labor. Even if you are in a situation where you can raise your prices to cover increased costs of doing business, it is still vital to the long-term health of your company to make sure that your labor dollars are being spent efficiently.
Are yours? How do you know?
The best way to measure this is to find out how many dollars of gross profit do you generate for each dollar of labor spent to produce that gross profit. Once you know how you did last month start to work backwards through time and look at your trend. Is it improving or is it declining?
The calculation is relatively simple but requires that a few line items of your P&L Statement get refined.
Cost of Goods – 4,000,000
Gross Margin $ 6,000,000
Direct Labor $ – 1,500,000
Contribution Margin 4,500,000
Overhead Expense – 3,000,000
Profit before Tax 1,500,000
Taxes – 450,000
Net Profit $ 1,050,000
In this example the company has a 60% Gross Margin and a 45% Contribution Margin.
They spend $1,500,000 in Direct Labor (without benefits or taxes, just wages and salaries) to generate $6,000,000 in Gross Margin. For every dollar of labor spent the generate four dollars of gross margin. This is known as a Labor Efficiency Ratio.
This result is neither good nor bad, it depends on whether in the past they were generating $3.50 or $4.50 of Gross Margin for every $1 of Labor spent.
Are you spending your labor dollars efficiently? Is there room to improve productivity? Are there steps that can be eliminated or automated? If the example company was yours what could you do to get to $6 of Gross Margin for every $1 of Direct Labor spent?
Challenge yourself and your team to look at the labor dollars spent and the productivity of those dollars and then discover what can be done to grow the productivity of labor and efficiency of the use of labor dollars in your company.
What is your Labor Efficiency Ratio and how much more efficient could your team become?
Dave Baney is the founder and CEO of 55 Questions, LLC and author of “The 3×5 Coach: A Practical Guide to Coaching Your Team for Greater Results and Happier People”, which is now available in Paperback or a Kindle version at https://tinyurl.com/y8ecykfy
At 55 Questions, we work with successful top executives with a driving ambition to crush their competition. We help CEOs and Entrepreneurs improve alignment, communication and accountability throughout their organization. www.55Questions.com
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