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In an effort to standardize business practices to create a one-size-fits-all formula, academics and intellectuals have created a number of myths that are damaging to business. Among them is the myth that says payroll should never exceed a certain percentage of revenue. Feel free to ignore this myth. Not only is it not helpful but it might also be damaging if you obsess over it.

Payroll as a percentage of total revenue is meaningless for one simple fact: there is more to the total cost of payroll than simply the amount of money that goes out in weekly paychecks. The total cost of payroll includes:

  • recruiting and hiring new workers
  • training new workers
  • gross wages and additional pay
  • health insurance benefits
  • other benefits (including life insurance, retirement plans, etc.)
  • federal, state and local taxes
  • unemployment insurance
  • state disability insurance.

Tying all of this together is the amount of money spent on administering payroll. In addition, payroll administration expenses rise and fall in correlation to the number of employees on the payroll at any given time. It should be apparent that with these things to consider, payroll as a percentage of revenue is not a calculation with any real value.

Payroll Should Be Controlled by the Results

If payroll as a percentage of revenue is meaningless, how should companies go about managing it so it does not get out of hand? Payroll should always be controlled by the results it produces. Labor costs provide an excellent example illustrating this point.

Let’s say a small business employs a payroll department consisting of three people who all earn a full-time salary and enjoy benefits such as vacation time, health insurance, and a decent retirement plan. The company spends a significant amount of money to keep payroll in-house. As the business expands, it must start thinking about adding a few new employees to the business office.

That company would be wise to start looking at online payroll services to see if outsourcing payroll would cost less in the long run. If so, they could sign on with a payroll service provider and transfer those three employees into the business office rather than adding new workers. Doing so would result in greater productivity for less money by controlling the growth of payroll through services that can be outsourced less expensively.

Spending Money to Make Money

Another factor to consider is the old adage that says you must spend money to make money. If results should control payroll, companies have to look at their long-term goals and how they expect to achieve them. One company may have to absorb a higher than expected payroll in order to support future growth while another company may choose to forgo that growth in order to keep payroll at its current pace.

Let’s face it; payroll is the single biggest expense for nearly every company. It is awfully tempting to try to control payroll by limiting it to a certain portion of overall revenue. But doing so is to be shortsighted and unnecessarily restrictive. A better strategy is to allow results to control payroll.

Companies should be willing to invest in payroll to whatever extent is necessary to achieve company goals. If that means spending a larger percentage of revenues now in order to generate greater profits later, that is not a problem. If it means streamlining to better utilize all the workers currently on the payroll, that is wise too. It is not about a percentage of revenue. It is about results.