Two More Tools to Ensure Better Profitability

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 ([email protected]) is VP finance/
operations of Ferrari Color, a digital-imaging center with Salt
Lake City, San Francisco, and Sacramento locations.