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Two More Tools to Ensure Better Profitability

Cost-to-sales ratio and sales-to-employee cost factor help managers understand their company.

As I've discussed many times in this column, one of the keys to running a successful business is having comprehensive and accurate data at your disposal. While monthly financial statements are the most common means used to review the progress of a business, financial statements sometimes don't tell you everything you may need to know.

This month, I'll identify two specific tools you can use to provide some detailed feedback on specific company areas: a cost-to-sales ratio, and a sales-to-employee cost factor.

The true costs of sales reps
Sales and marketing costs incurred by a business seem to always represent a significant expense on the income statement. So how do you know if you are actually making money from your sales and marketing department?

If your company is like most, some sales reps will be making you money while others will not. Choose to only review sales and marketing expenses as one line item off your income statement, and you may have a difficult time determining the actual expenses tied directly to each sales rep. The amount of sales generated by a given sales rep will always be the leading indicator of his or her success, but relying on only the monthly revenue the sales rep generates probably does not provide the whole picture.

The goal in this analysis is to gain a measure of the true monthly cost of each of your sales reps, and compare that to the sales they're generating. We'll call this our "Cost-to-Sales Ratio."

Begin by accumulating all costs pertaining to each sales rep. This includes: base salary, commissions, payroll taxes, employee benefits, all expenses related to phones, computers, auto allowances, travel, entertainment, and any other related costs. Summarize these costs monthly, and then divide them by the total sales generated during that month. The result will be a ratio depicting how that sales rep has performed during the month.

This can be an eye-opening exercise. As managers, we often think of our sales rep costs only in terms of salaries and commissions. Taken alone, that ratio would probably be somewhere between 8 to 12%. When adding the additional expenses I've just indicated, however, that percentage can quickly jump. If, after adding all of these costs, your costto- sales ratio is below 15% on a given sales rep, he or she is probably making you money. On the other hand, if the ratio rises closer to 20%, your sales rep may not be generating enough margins from sales to cover the costs of producing your work. Reviewing this ratio on a monthly basis will help you determine how your individual sales reps are doing.

Monitoring employee creep
Like sales and marketing expenses, labor costs can also be a difficult cost center to get your arms around. Often, businesses will experience what I call "employee creep." No, this isn't nomenclature for a nightmare employee doing stupid things on your company's time; rather, this is a description of the familiar episode of waking up one day to discover that your business has slowly added several new employees to the work force, yet sales levels are the same or below what they were previously. A tool called the "Sales-to-Employee Cost Factor" can provide you a way to monitor employee creep within your own organization.

The first step in determining this factor is to convert your total labor force"?whether direct labor, administrative, or management "?to a full-time equivalent employee number (FTEs). For instance, if you have an employee working 20 hours per week, he would be an 0.5 FTE employee. Someone working 30 hours per week is an 0.75 FTE employee, and so on.

Once you have a total FTE number for your company, divide that FTE number into your total sales for the month. This formula calculates a number describing the amount of sales generated by each FTE employee during the month. Tip: You may wish to round sales off to the nearest thousand so your calculated number is more manageable.

Re-calculate your FTE formula each month"?allowing for seasonal hires, layoffs during slow periods, temp labor"?and keep in mind that just using an average for several months will not provide an ongoing accurate measure. While the sales-toemployee cost factor can be analyzed by itself and provide some useful information, it's best analyzed over several periods (preferably monthly), to indicate trends about how your employee base is being utilized from month to month relative to the sales generated in those same periods.

Years ago, I sat in a class at a trade show and listened to the speaker hypothesize that in order to be profitable in the graphics world you must produce at least $100,000 per year per FTE employee (or $8333 per month). Upon returning home, we immediately began calculating our own company's numbers to see if we were producing that level in revenues. Since that time, we have consistently utilized this formula on a monthly basis to monitor our employee levels"?it's become a very accurate barometer to indicate where our employee levels are relative to our sales.

Varying capital expenditures and equipment investments will determine on what level your business will function in terms of revenue generated per employee. You can't invest heavily in technology and equipment, retain the same numbers of employees, achieve the same revenue streams, and expect to remain profitable. In our own company, for instance, because of technology and equipment expenditures, our sales-to-employee cost factor has increased by close to 50% over the past five years.

To establish your own benchmark, review past periods that have been profitable and recreate the sales-to-employee cost factor for those periods. This will create a baseline factor where you know your business can be successful. This tool will then become more consistent and useful for your analysis.

Understanding your own company
The tools I've addressed here are by no means the only two you can use. These ideas, however, should stimulate some creativity within your organization to help you conceive of your own unique cost-analysis tools that will be beneficial for your business. A continual scrutiny of your company should lead to greater understanding and faster improvements.

Marty McGhie (marty@ferraricolor.com) is VP finance/ operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations.

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