The Single Biggest Driver in Your Business
Most business owners know this, but completely under appreciate the significance.
I have spoken on this previously, and even for those that I coach, seldom is the significance of the human cost fully appreciated.
For a service-based business the cost of employees is often the biggest single cost. Compare this to an importer who ties up a lot of their capital in stock and warehousing, their employment costs as a percentage of total costs are a whole lot lower. But this difference masks the reality that in almost every business the employment cost, is the ‘cost’ that is the biggest driver in influencing the bottom-line performance of the business.
Why then, if employment costs are often the biggest cost item, and have the largest impact on bottom-line performance, does your accounting programme (and your accountant), not separate these costs out?
Usually, these costs are just up in the COGS (cost of goods sold). How useful is this to you?
The reason why they report these costs like this, is because this is the way it has always been done.
A simple analogy to illustrate the situation is to compare the employment costs to a seesaw. By correctly positioning your employment costs you can balance the revenue-cost equation in your favour.
For most businesses, making or losing money comes down to how well the humans in the business are playing the game. How engaged are they? How well do they understand what really drives performance?
To assist you in directing their attention to the business numbers, do they have a ‘stake’ in the outcome?
In terms of our financial management reporting, we like to express the staff costs in a ratio format. That way, when the revenue changes we can quickly determine how productive our employment costs are, as well as being able to show exactly where these costs should be in order to achieve our profitability target.
This ratio is what we refer to as our Direct Labour Ratio (DLR). The DLR is both an important and a meaningless number at the same time. On the one hand it is an easy number to conceptualize, as in, for every $1 we spend on direct labour, we expect $X in return. But on the flip side, while it is important to know the company’s overall DLR, it is often difficult to measure the DLR at the individual employee level.
The fix here is two-pronged.
First, we need to get creative in figuring out how we can measure this at the individual level, and this needs to be easily and consistently measured.
Secondly, at the individual level, there may be a bunch of other leading indicators that you can easily measure which in turn directly influence the lagging indicator, which is the DLR.
If you are a business owner, then you need to be ‘all over’ this Direct Labour number and the ratio. Maybe you are, but if not, then it could be worth your while exploring this further. PS. Contact me.
PS. I am working on a management focused, financial workshop, would you like to attend this?
PPS. Recently I wrote a White Paper on this subject, you can grab a copy of that here.