Understanding where your revenue is spent tells you if your products are priced right in comparison to your overhead and other expenses. Having the correct number of employees and paying them a fair wage helps your company's bottom line. However, if your salaries are a high percentage of your company's gross profit, then you might need to adjust your business plan to become more profitable.
The gross profit of a business is the total revenue from sales minus the cost of goods sold, which is the expense in purchasing products for resale or the material to manufacture them. It might seem obvious that items should be sold for more than it cost to acquire them. However, if a business owner does not perform satisfactory research using actual anticipated expense amounts, the company might not stay afloat after the first batch of products are sold. The gross profit must be enough to cover other expenses, such as salaries, and leave a sufficient net income when all assets and liabilities are considered.
Employee salaries are a part of a company's operating expenses, which are subtracted from gross profit to realize your net income. Marketing, utilities and the building lease are examples of other operating costs. Recognizing the percentage of salaries in the operating expenses is important and varies by industry. Businesses specializing in the manufacture of products for daily use should pay salaries that are around 20 percent of the operating expenses. This doesn't mean that the industry employs fewer workers, but that other expenses for manufacturing are higher than those of the salaries.
Percentage of Gross Profits
Knowing the percentage of your gross profit that is spent on salaries can help you understand if the employees' performance raises income enough to compensate for the cost. If your salaries are a high percentage of gross profits, then your staff is not generating enough revenue to support the positions. They might be office workers or sales representatives, but the duties performed should increase, in some way, the company's profits because you must pay wages regardless of your revenue amount. Each industry and business must do its own analysis on the ideal percentage spent on salaries. However, a rule of thumb is to have 15 percent to 30 percent of your gross profit used for wages.
Count your owner's salary when calculating percentage of gross profit. Because you can't live without a paycheck forever, inflating your profit by ignoring your personal wages is not an accurate representation of the financial health of your business. If you find that your expenses are too high, you might not be able to increase the price of your products because of market competition. Therefore, staff members who are not vital to revenue producing positions may need to have hours reduced or be laid off.