What Portion of Revenue Should Go to Payroll?

This story appears in the November 2014 issue of Entrepreneur. Subscribe »

Q: Is there an ideal percentage of revenue that should go to payroll?

A: In my opinion, anyone who claims such a thing exists is full of it. Truth is, the figures vary widely among not only entire industries but also among the companies within them.

Some industries pay low wages but have high rates of employee turnover (fast food being the prime example). The low wages may be great for owners, but turnover usually results in high costs for acquiring and training replacements—expenses that need to be added to the total cost of payroll.  

The age of your staff can make a difference, too. Having young workers may provide opportunities to limit your costs for medical insurance, life insurance and retirement plans, since many young people won’t avail themselves of these benefits even if offered. (This is no excuse to practice age discrimination. I bring this up to point out the sizable—and growing—costs associated with benefits beyond wages.)

To find the right percentage for your business, start with a competitive analysis, but don’t strive to find an average number for your industry. You want to figure out what the highly profitable companies in your industry are doing. Trade associations can be a gold mine in this respect, especially for learning about members outside your local market with whom you don’t compete directly. 

Depending on what industry you’re in, there may be journals or reporting services that track this financial information. If a subscription to such a service is too expensive for your company, seek out a resource who may be a subscriber, such as your financial advisor, an accounting firm or an outside CFO like me. When I share reports from these services with my clients, they are usually shocked (in good and bad ways) by what they learn and then delighted to have the information.

Most important: Don’t obsess over achieving the “proper” percentage—it’s a guideline, not a law. If labor is a relatively unimportant cost for your business, you can still complete this exercise, but focus on other areas first; doing so can help you reduce overall costs. Additionally, keep in mind that if your long-term growth and profit strategies require creative types or high-level (read: expensive) sales, operational or management experts, you’ll have to pay for them now to set things in motion for the future.

Figure it out

How to calculate the percentage

To reach your revenue number, use your gross revenue minus sales taxes or items such as freight charges that you collect but then pass on to the shipping company, or equipment rentals that are billed to your client. Then tally up your total labor costs, including every item associated with employee compensation. Here’s a quick list:

  • Gross wages
  • Paid vacation pay
  • Health insurance
  • Life insurance
  • 401(k) contributions
  • Auto allowances
  • Other benefits
  • FICA taxes
  • Other state or local taxes
  • Unemployment insurance
  • State disability insurance

Divide your payroll number by your revenue number, multiply by 100, and that’s your percentage. 

Edition: October 2016

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