A Quick Guide to Managing Labor Efficiency

How efficient are your labor costs?

Let's look at a concept that can help both service-based businesses and product-based businesses with managing arguably their largest expense line.

It's called the Labor Efficiency Ratio (LER).

What is it?

It's a simple but powerful metric used to measure the effectiveness of labor costs in any business. To calculate your LER, take your gross profit and divide by labor costs (ideally over a 12-month time period).

Let's say your business has annual gross profit of $500,000 and total payroll of $260,000... that works out to a ~1.9x LER. This means for every dollar spent on labor, you're generating $1.90 in gross profit. Sounds like a pretty useful metric to track over time, huh?

How should you use this tool?

• Aim for 2.0x ($2) or better – Consider 2.0x an informal benchmark, but obviously the higher the ratio the better. And don't forget to take labor costs out of your gross profit calculation to get the most accurate read on labor efficiency.
  ​
• Track over time – Calculate this metric regularly. I'd suggest doing it every month alongside a rolling 12-month analysis. Charting it visually helps to see trends and patterns (see below). Simply knowing where you are is the best place to start.
  ​
• Profit predictor – Labor efficiency is a great equalizer when it comes to predicting profitability. Since we use gross profit in the numerator, it doesn't matter what your topline is or what industry you're in. No matter the business, the greater this ratio, the more profit you're likely to have.

Here's a look at a live LER for a business I work with:

This company went through an initial period of steady improvement in labor efficiency, then hired for growth during a "reset" period, and now they're starting to see improvements again. It was a great tool when it came to making key hiring decisions for this company.

Key takeaway...

Remember, the goal isn’t just to cut costs but to maximize the value generated by every dollar spent on labor. With an eye on your LER and a plan for continuous improvement, you’ll see substantial gains in profitability.

Have questions or need help with your LER? Feel free to reach out—I’m here to help make sense of your numbers.

Some product announcements

We're rolling out a new platform for our courses and offerings. Along with it are some new features, check them out!

• Monthly membership (includes access to all courses, content, and live classes)
• Profit community (an online community for our members discussing their profit goals, questions, wins, and tips).