Did you know that the number one driver of profit is labor efficiency? Labor efficiency, also referred to as L.E.R., or your Labor Efficiency Ratio, is a measure of productivity output of each dollar spent on labor.
L.E.R. doesn’t just focus on labor cost as a percentage of sales. The idea of L.E.R. is to set a goal for every dollar spent on labor to receive back four dollars, as one example. Increased profit is realized by achieving the right multiple for each position or work classification.
The formula for Direct Labor Efficiency equals:
Gross Margin Dollars divided by Direct Labor Cost.
Management Labor Efficiency equals:
Contribution Margin divided by Labor Management Costs.
Sales Labor Efficiency equals:
Contribution Margin divided by Sales Labor Costs.
Contribution Margin is:
Gross Margin minus Direct Labor.
Many accountants refer to gross profit, but that mixes direct labor costs with non-labor costs. And that’s a problem, because it masks the productivity of labor.
The key difference is that you want to view labor as something you can leverage. As long as you can apply labor at the right multiple, you will know the right number of people required to grow the business, and specific areas to apply training and rewards.
In order to get started, you need to decide which work functions you will focus on. Start with direct labor or those employees that spend 50% or more of their time producing the product.
All other labor applies to management, except for sales people. Only use wages and incentives (not taxes) to keep it simple.
The goal is to achieve 15% net profit. Growing sales without increasing profit will reduce valuation and increase risk of business failure.
Most company’s net profit is less than 8%, based on industry averages. By focusing on L.E.R., we’ve seen net profits increase to 10%, 12%, and even 15%.
The real wealth of an organization lies in the knowledge of all of its people and how that total knowledge is then leveraged to improve. The reason for this is that the methods your team learns now will continue to have an impact on profits for many years to come. Yes, training in labor efficiency is an expense, but that expense could double or triple your net profit faster than you can imagine.
Contact Us Today, and we would be happy to demonstrate how we helped 3 companies increase their L.E.R. by 50 to 100% last year, and how we would apply our training tools to help you do the same.
Topics: Labor Efficiency