Determining what percentage of your revenue should be spent on salaries is one of the most important decisions for your business. If the percentage is too large, you risk running out of money for other expenses. If it's too small, you risk losing employees to competitors. While there is no set percentage you should be devoting to your payroll, there are some rules of thumb you can follow to ensure your payroll budget is in the right range.
The generally accepted formula for calculating the portion of your business devoted to salaries is salaries as a percentage of operating expenses. Simply add up all the operating expenses in your company, including research and development, supplies and equipment, and general and administrative costs. Exclude mortgage payments, building improvements and entertainment expenses, which are not considered operating expenses. Then add up all the salaries in the organisation. Divide the salary figure by the operating expenses.
The percentage of your operating expenses devoted to salaries will depend on the type of industry you are in. Utilities and manufacturing industries have large infrastructure costs that generally make up a much greater portion of their spending than salaries. Consider these Bureau of Labor Statistics numbers as a guide: Industries with the highest median percentage of operating expenses devoted to salaries in 2008 included the health care industry, with a 52 per cent ratio, and for-profit services, with a 50 per cent ratio. The lowest were durable goods manufacturing at 22 per cent, construction/mining and oil/gas at 22 per cent and retail and wholesale trade at 18 per cent.
While there is no blanket standard for how much each business should spend on payroll, considering some guidelines can help business owners determine whether they are on the right track. Most businesses should shoot for salaries in the 30 per cent to 38 per cent range, according to Second Wind Consultants. If yours are around 50 per cent, that is generally too high.
If your business is a start-up, it will generally take a long time before the percentage you spend on salaries, including your own, will catch up with established businesses in your industry. Instead, your own paycheck will most likely just be enough to cover your basic monthly expenses. Once your business breaks even, you will need to consider your profits before you can calculate how much you can afford to spend on raises for yourself and your staff. The best way to do this, according to "Entrepreneur" magazine, is to tie raises to the company's profit increases. If the company's profits grew by 10 per cent, you can afford to spend 10 per cent more on salaries.