Labor vs. Revenue Ratio
Investors, owners and managers often review and assess a wide swath of internal numbers to determine how well a company is performing. Comparing one set of numbers to another yields ratios that provide valuable insight. One comparison is the labor versus revenue ratio. This ratio tells how efficiently a company is utilizing its people. Its counterpart, revenue per employee, is more frequently used as an actual comparative ratio.
In general, companies do not calculate a “labor vs. revenue ratio.” Companies look at their overall labor costs and compare these to those of their peers and others in the industry. For an effective comparison, companies must compare more than raw data. Number of employees, total labor costs or revenue offer almost no analytical value when examined alone. A company with $5 million in labor costs may be high or low depending on its overall revenue and the labor-intensiveness of tasks performed by workers.
Businesses calculate revenue per employee by dividing total revenue by total number of employees. Through the use of the revenue-per-employee ratio, a company can determine efficiency and use that assessment to make adjustments to operations.High revenue per employee indicates that a company has found additional ways to obtain more sales from each employee. Increased efficiency means lower relative labor costs, improved margins and greater profits.
Distribution Products Inc. has four part-time and five full-time employees. Last year the company generated $600,000 in revenue. Using a straightforward calculation for revenue per employee yields $66,666.67 per employee, or $600,000 divided by nine. However, the four part-timers work 20 hours per week. Therefore, the part-time personnel translate into two full-time equivalents or FTEs. The true revenue per employee for Distribution Products Inc. is $85,714.29 or $600,000 divided by seven FTEs.
When examining labor vs. revenue, a company must examine its historical trends and determine how they relate to its current situation. A labor cost of $85,000 per employee may show a rise of $10,000 per employee over the previous year. If the company is growing, it may be investing in personnel to build the infrastructure to support expansion. As the business grows, it can leverage more of each employee's time and reduce this number. If the company is stable with rising labor costs, it may need to identify and implement changes to increase productivity.
Labor, in both dollar terms and number of employees, is higher in labor-intensive industries, including construction, landscaping and consulting. Industries that rely on technology or equipment, including certain manufacturing sub-industries and software technology, have lower labor numbers and costs. Therefore, it is critical that companies compare receipts per employee or overall labor costs to those of other companies in their industry to avoid erroneous conclusions.