06/ 17/ 2004
by Jeffrey Moses
A key calculator for small companies is the Total Revenue/Employee ratio. This is calculated by dividing your company’s total revenue by the number of employees in your company (owners included, assuming that they earn salaries). You can obtain interesting and valuable information from this ratio.
Say your company has a gross annual total revenue of $1.5 million. If you have ten employees, yourself included, your company has total revenue of $150,000 per employee. If you have been profitable at this ratio for some time, you can roughly determine that you’ll need an additional $150,000 in revenue before you can comfortably add another employee. If you add employees before that additional amount has been generated, you may sacrifice profitability.
Additionally, you can roughly calculate how much an additional employee should be expected to generate for the company, if the company is to remain at the same level of profitability. Using the ratio as outlined above, you could hire a new employee when you feel it likely that your hire would be able to generate about $150,000 in total new sales. This takes some of the guesswork out of hiring.
Continuing with the above example, if your average employee is paid $40,000, you have remaining $150,000-$40,000=$110,000 per employee for other operational expenses, such as production, purchasing, marketing, ongoing bills or debt service. This figure ($110,000) is the average revenue generated by each employee. The more money per employee you have for expenses other than salary, the more the average employee is generating in income. By reviewing this figure regularly, you can determine if your employees are remaining at the same level of financial effectiveness. Successful companies continually strive to increase the average level of employee financial effectiveness – this is the only way to remain competitive for the long run.
The average employee salary in service companies may be nearly as much as the Total Revenue/Employee ratio, because the majority of revenue is spent on salary. For example, an advertising agency with total revenue of $1.50 million may spend nearly $1.0 million in salaries, because the company’s "product" is the creativity of its employees. A company that assembles metal furniture, on the other hand, will spend a higher percentage of its total revenue on materials, less on the creativity of its employees. This means that the average employee salary will be a lower percentage of the Total Revenue/Employee ratio.
Whatever your industry or type of company, the average revenue generated by each employee should remain constant or rise over time. As a company grows and adds employees, total profitability can increase even as the average revenue generated by each employee falls. But maintaining the level of revenue generated will strengthen the underlying fundamentals of a company and increase the likelihood of profitability in the future.
