Payroll done backwards

How are you calculating what you spend on payroll?

A study by Payscale, Inc., a compensation analysis firm, reported in the Wall Street Journal that only 38% of employers have a formal compensation structure or philosophy guiding their pay decisions. Of the 7,600 firms in the survey, the majority state they are making it up as they go.

Those businesses that offer incentive or bonus pay appear to be in the same category. Without a plan for how raises are to be determined and without predetermining what incentives or bonuses are to accomplish, it is no surprise when the owner asks how much they should be spending on payroll.

What we have is a business that most likely gives no consideration to pay until there is a problem with the bottom line of the business. Let’s spend some time working to resolve this.

While any industry can have “guidelines” for pay as a percentage of income, we should first look at what is a part of pay. It begins with the gross pay of your employees. We add to that amount, all of the payroll taxes for the employees.

Also to be added is the workers compensation your business pays as well as any insurance related to employees. It is at this point that when an owner begins to look at payroll as a percentage of revenue, we do so with several caveats. This is because the pay of certain individuals, family members and manager/owners can greatly affect the answer.

This writer thinks about the owner who hired his son as manager. The owner knew that the pay he was giving the son was much higher than a manager would earn, but did so gladly. However, he has to be observant of his business not likely having pay as a percentage of revenue at the level he would prefer.

A similar situation was a business where the owner’s pay was set to 10% of sales. Again too high for the percentages to work correctly for the business but it was the appropriate tax strategy for the business owner.

Another area of concern is that of a business in which service is a part of the income. If service calls for the installation of a $20 part and the total of the service ticket is $150, the business did not make $130. This is because the cost of the labor to install the part, and the cost of the service ticket writer are not included.

When done properly, this labor is a part of the cost of doing business, similar to the cost of goods sold, and is not a part of the payroll calculation when looking at payroll as a percentage of revenue.
All of that prefacing said, the first step is to determine what percentage of revenue is dedicated to the whole of payroll. However, even if a business is a part of an industry that does annual cost of doing business among its members, that number cannot be taken as absolute. There are several reasons for this.

The first is that of the regional of the country the business is in. The second is the survey itself. There is no guarantee that the same businesses participate in the survey each year. There is no guarantee that all businesses are using the same logic for payroll that is explained in this column. And lastly, there is no guarantee the business owner is telling the truth in what they are reporting.

A business should look at dividing payroll into sales, management and support. While sales and management are somewhat self-explanatory, support would include those employees working in the office and stock room. While the owner is a part of management, and you want to get as much out of the business as possible, some of that money going to the owner can come in some form of the profits. Management, however, is not direct interaction with customers. The same can be said for the support. If a business believes that great customer service is their advantage over an online business, box, chain or mass merchant, then that business wants to put as much of the payroll budget into sales as possible.

In dividing that money for sales people, you have to decide if you want more people at a lower per hour rate, or fewer people at a higher hourly rate. Keep in mind that there is nothing that says the hourly rate is going to determine the quality of the people you hire, or their ability to sell.

This is where incentives and bonuses can separate those who can sell from those who cannot or do not want to sell. (Yes, some of us have employees who think their job is to be there instead of selling.)

Not just a play on words, but there is a difference in bonuses and incentives. The incentive is a reward for doing something; with sales people it is often selling more. Any incentive you establish has to consider three factors; the employee wins, the store makes money and the customer is not taken advantage of.

A bonus is simply more money without any specific action being taken. An example is an owner of multiple stores who had an annual Christmas party, during which the bonus checks were distributed. He commented that there was a set dollar amount for managers, a smaller amount for assistant managers, and a third amount for the rest of the staff. It had been done this way for years.

As his stores closed at noon on Saturday and the party was a Saturday night, I asked if he thought any of his employees were out spending that bonus on the afternoon before they received the actual check. There is no incentive in a bonus.

It is never too late to begin to make changes in how payroll is calculated. But determining the pay amount when someone is hired, or a similar action in determining an incentive pay, is definitely not the way that leads to a more profitable business.

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