Paul Downs, owner of Paul Downs Cabinetmakers, starts all of his employees above minimum wage, according to the New York Times Small Business Blog. Beginning with a wage of $10 per hour for employees who show up to work reliably, Downs’ wage structure extends up to $30 per hour for foreman-level work. His wages reward his employees for skills, dedication, and leadership, but Downs admits in a follow-up blog post that his payroll costs have to come directly out of his client’s pockets.
If he gets the balance wrong, he may not have enough revenue to cover operating costs or write payroll checks. Finding the perfect balance for payroll is a struggle for all small business owners, but the following guidelines can help you figure out how much you should be devoting to payroll each year:
Percentage of Revenue
Businesses should plan to devote 15 to 30 percent of their gross revenue to payroll, and according to Second Wind Consultants, businesses within this range tend to be the most successful. However, it is sometimes necessary to make adjustments, and businesses in the service industry may spend up to 50 percent of their revenue on payroll. To keep the numbers accurate, use payroll software to track everything, and don’t forget to include your own paycheck or owners draw, as well as employee benefits and workers compensation costs. The Society of Human Resource Management has online calculators to help you determine employee benefits and other features as a percentage of revenue.
Raises and Bonuses
Once you have successfully indexed your payroll costs to your revenue, you need to make a plan for adjustments. If you experience a seemingly permanent increase in revenue, you can pass that on to your employees in the form of a raise. To give yourself some breathing room, keep the raises slightly under the shift in revenue. For instance, if you’ve experienced a 10 percent rise in revenue, give your employees each a 5 percent raise. If you’ve just had a temporary revenue windfall, give some back to your employees in the form of a bonus. You can even index management bonuses to your revenue, which can be a powerful motivator.
Missing the Mark
If you spend too much on payroll, you won’t have enough operating capital left over to make essential investments, and your business will suffer. On the other hand, underpaying employees can damage morale and hurt your ability to maintain old employees and attract new ones.
Calculating payroll as a percentage of revenue doesn’t work for every industry, and there are alternative models. If you have a team of salespeople, consider paying them a nominal wage paired with a bonus or commission structure based on their sales. Using this approach, your payroll will grow in direct proportion to your revenue. If you have multiple departments, consider charging each department with covering their own payroll. For instance, if you own a restaurant, the kitchen staffs’ salaries need to be covered by revenue generated from food, while the bar staffs’ salaries need to be covered by revenue generated by liquor sales. Ideally, you will need a department manager to oversee scheduling in each area for this to work successfully, but you can also track the numbers on your own if you prefer.