Are Labor Costs Eroding Your Profitability?

In 2015, researchers asked a random sample of Americans a simple question: how much profit do you think companies actually earn on the dollar? Their response: 36 percent, or $0.36. The real profit margin for the average company? Around 7.5 percent, or just $0.075 on every dollar.

For business owners, these numbers don’t come at a shock. Many mid-sized businesses operate within small profit margins, and with even less margin for error. It can be a razor-thin edge that leaves a lot of consumers wondering—where does the rest go? Easy. Start with rent, add inventory, and combine with one of the biggest expenses of all: labor.

How hidden labor costs impact your business

According to the National Restaurant Association, almost two-thirds of restaurant operations costs go to food and labor, regardless of service or price level. While there’s no “perfect” number when it comes to how much money businesses should be spending on labor costs, Forbes found that payroll costs can account for as much as 33 percent of sales to as little as 4.7 percent of sales across different industries. Depending on your business, a $14/hour employee on paper can quickly turn into a $20/hour employee after taxes, uniforms, paid time off, and benefits. Eventually, the total cost per employee can end up being 18 percent to 26 percent more than their base pay.

With these rising labor costs, even a few hours of overtime can completely erode your profit margin day-to-day. If you’re paying more for employees to be on the clock than customers are paying you, you’re already in the red. It’s easy to dismiss once or twice, but those few instances could reflect a larger scheduling trend.

Scheduling and other labor costs impact not just your bottom line, but also your own time. The average restaurant or office manager spends upwards of 7 percent of their week on employee scheduling and 70 percent regularly log additional hours to handle administrative tasks. The hours you use trying to predict staffing needs, scheduling employees, and balancing limited staff equal more labor costs (again, dreaded overtime) and less time for you to put into your business.

Find out how much of your dollar goes to labor

Sales and labor are undeniably connected. In order to understand your labor costs, first, check in with your POS and find out how your sales compare to the number of employees scheduled. This alone can quickly provide insight into the relationship between your current profit and labor costs. But to get a real percentage of how much of your profit is eaten by labor, simply divide your total sales by your total labor costs (including benefits and overtime).

Remember: there isn’t a perfect percentage when it comes to labor costs. You have to identify the right number your business needs to succeed. Not sure what that should be? Start by researching average costs for your industry. For example, payroll usually absorbs 15 percent of sales revenue for a retail clothing store. If you run a retail store, calculate your labor cost percentage and see where you stand.

Identify trends in your current labor costs

At this point, you may have realized that your labor costs outweigh your revenue more often than not. But take a breath before you slash hours; fewer employees don’t automatically equal more profitability. Instead, understaffing can make you pay for both overtime and fewer sales. In a study of 11 startup companies, those that hired fewer salespeople missed out on “tens of millions of dollars in additional sales and profits in their first three years.”

Frustrating as it is, staffing requires a bit of a Goldilocks approach. Too few employees, and you won’t have enough staff to make sales. Too many, and labor costs will overpower your daily revenue. Ultimately, you need to find a way to schedule in sync with your sales forecast and land on a combination that’s just right for maximum profitability.

How? Go back to your comparison between sales and employee schedules. Make a note of each time that your labor costs outpaced your sales and see if the same pattern repeats itself more than once. The more you track, the more you’ll begin to recognize scheduling trends alongside your sales. You’ll notice the shifts that are constantly pulling overtime and start seeing where you over- and understaff. And just like you forecast sales, you’ll be able to better predict your labor costs to match.

Eliminate unnecessary labor costs

Once you have the data you need, it’s time to put it to work. Instead of guesstimating or crossing your fingers for a busy shift, use an employee scheduling software or another data tracking resource to staff according to your sales forecast.

Remember how you used to spend 7 percent of your week making schedules? Spend those now-free hours empowering your employees to trade shifts or find replacements on their own. Add a board where workers can post looking to pick up shifts or share out an updated protocol of what employees should do if they’ll have to miss work. The easier it is for your employees to communicate and quickly find a substitute, the less chance you’ll have of paying overtime due to others staying late for missing employees.

You can also cut down labor costs by cross-training your employees. Train your employees in multiple areas of the business and schedule them throughout each shift. If one employee doesn’t show up for work, you’ll already have an employee on location to step into their shoes.

Soon, you’ll know exactly how many employees you need for a given weekend, allowing you to spread labor across other parts of the week. If your business is seasonal, you’ll be prepared to hire additional staff or downsize your current workforce. You may not always get it right, but with time and the right tools, you’ll be able to keep labor costs under control instead of labor costs controlling your business.