The payroll-to-sales ratio is a financial ratio that helps managers evaluate employee productivity. If the ratio skews too high or too low, the business may need to reconsider its staffing levels. Not all changes in sales are a product of employee efforts, so managers should consider several metrics when evaluating productivity levels.
1. Figure Payroll Expense
Calculate the total amount of payroll expense you incurred for the period. Payroll expense includes hourly wages, salaried wages and the employer-paid portion of payroll taxes like Social Security and Medicare. When determining payroll expense, include any payroll expense that's been accrued and not yet paid. For example, if you're calculating payroll expense on March 31, you should include payroll expense incurred for the March pay period even if the checks aren't cut until April 1.
2. Determine Sales
Calculate total sales for the period. Sales are revenues from all sources minus sales returns and allowance for doubtful accounts and sales discounts. For example, if revenue for the period is $500,000 and the company reported $5,000 in sales returns, discounts and doubtful accounts, sales for the period are $495,000.
3. Calculate the Ratio
Divide payroll expense by sales to calculate the payroll-to-sales ratio. For example, if payroll costs for the period were $200,000 and sales were $495,000, the ratio is 40 percent.
4. Interpret Findings
In general, the lower the ratio, the more sales revenue each employee is bringing in. Payroll costs and sales revenue usually move in the same direction, so the ratio ideally should remain somewhat constant as the business grows. If you notice the ratio declining, you may need to bring on more staff to support operations. If the ratio is increasing, productivity may be declining or employees may not have enough work.
The payroll to sales ratio isn't infallible. The metric tends to work well for sales and customer service employee productivity because the work in these departments has a strong correlation with sales levels. However, the workload of other departments -- such as human resources, accounting and legal -- aren't necessarily correlated with revenue levels. To avoid misleading results, experts recommend using a variety of benchmarks when evaluating productivity.