Finance · Proving to Scaling
What your people bring in
You work out how much gross profit every euro of wages brings in, compare it with the benchmark for your sector, and know how much payroll your current gross profit can carry.
Worth reading first: Reading your P&L
Does this sound familiar?
- We took on five people this year, revenue went up, and there's less left over than last year.
- Everyone's busy, and the profit still doesn't add up.
- I hire someone as soon as there's work, and then it takes six months before they've earned their keep.
- The accountant says our staff costs are high, but not how high they're allowed to be.
- We compare our revenue per FTE with a competitor's, and we don't know if it tells us anything.
Who it's for, and when
For founders with employees who see revenue growing but not profit, or who aren't sure they can afford to hire. In Proving it's about your first few people and whether clients pay for the work. From Organising onwards, wages are your biggest cost and you hire faster than you can keep track of; this is the number that tells you whether your team and your revenue fit together. In Searching it's too early: while you're doing the work yourself, there's nothing to divide.
The model
In a service business, your people are your biggest cost. Staff costs as a percentage of revenue don't tell you much: a business that resells a lot of bought-in goods has a low wage share, even if its people bring in very little. So Greg Crabtree, an American accountant to small and mid-sized businesses, sets wages against gross profit: what's left of revenue after cost of sales. That's the money your people earn themselves.
The Labor Efficiency Ratio is gross profit divided by wage costs. Crabtree works it out in two steps. The direct LER divides gross profit by the wages of the people who do the client work. What's left after that, the contribution margin, you divide by indirect wages: senior leadership, sales, office. That's the management LER. In Boldcaster the first one is called dLER, on the Value development screen.
Wage costs are everything an employee costs you: gross salary, holiday pay, employer's contributions and pension. Your own salary counts too, at market rate. If you pay yourself little and take the rest out as profit, your dLER looks better than the business is. Put your own hours in the group they belong to: if you do client work yourself, that part counts as direct wages.
Crabtree calls a direct LER of 2.0 the rule of thumb: every euro of direct wages brings in two euros of gross profit. Boldcaster adjusts that benchmark per sector, because a law firm works differently from a construction company. Consultancy, legal advice and engineering firms have a benchmark of 2.5, with a threshold of 2.0. IT services, business services, marketing and education sit at 2.0, with a threshold of 1.5. Recruitment at 3.0, accountancy at 2.2, construction and care at 1.8, hospitality at 1.6. For a sector without its own benchmark, the app shows Crabtree's 2.0 with a beta label, and it doesn't count towards your score.
Hiring pushes the ratio down. A new employee costs wages from the first month, and only brings in gross profit once they're up to speed and there's work sold for them. If you hire for revenue you don't have yet, you'll watch the dLER drop for a year. That needn't be a mistake, as long as you work it out beforehand and know when it has to be back up.
Revenue per FTE is the rougher measure. It's easy to compare, with other businesses too, but it says nothing about how much cost of sales is in the revenue, and nothing about what your people cost. Use it to see whether you're in the same range as your sector, and use the dLER to steer.
Greg Crabtree, Simple Numbers, Straight Talk, Big Profits! (2011), with the Labor Efficiency Ratio (LER) and the rule of thumb of 2.0 for the direct LER. The benchmark per sector in Boldcaster builds on that rule of thumb. Revenue per person per sector: Eurostat, Structural Business Statistics, the Netherlands, 2024.
Gross profit
Revenue minus cost of sales: materials, resold licences, media you recharge to clients. No wages. What's left is what your people earn with their work.
Direct LER (dLER)
Gross profit divided by the wages of the people who do the client work. Higher is better. If it's below the benchmark, your prices are too low, your people spend too few hours on clients, or you have more people than the work needs.
Management LER
Gross profit minus direct wages, divided by indirect wages: senior leadership, sales, office. It shows whether your overhead is in proportion to what delivery brings in. The app doesn't calculate it; the calculation is below.
Labour cost ratio
Direct wages divided by revenue. On the screen it's a sentence: of every euro of revenue, this many cents go to the wages of the people who do the client work. Lower is better.
Revenue per FTE
Revenue divided by the number of FTEs. Rough, because cost of sales and wage levels are in it. The audit compares it with the average for your sector from Eurostat.
Pitfalls
Mixing up delivery and overhead
A team leader who spends half their time on billable work belongs half in direct wages. Put everyone who isn't fully billable in indirect wages and your dLER looks better than it is. Pick one split and stick to it, or you'll be comparing years that can't be compared.
Contractors under cost of sales
A freelancer (zzp'er) doing client work counts as wages for this calculation, even if the books record them as cost of sales. Left there, your gross profit and your wages both drop, and you can no longer see what your people bring in.
Watch and read
Crabtree himself on why he sets wages against gross profit rather than revenue, and what a ratio below 2.0 tells you.
Watch on YouTubeFive minutes on the difference between the direct and the management LER, and how to get a ceiling for your wage costs out of it. The examples are from construction; the maths is the same.
Watch on YouTubeWhich wage costs to include, and how to clean up gross profit first. She also works with the wages of all your people together; the app calculates the dLER with direct wages only.
Watch on YouTubeIn Dutch: what comes on top of gross salary, such as holiday pay, employer's contributions and pension. That's the amount that belongs in your wage costs.
Watch on YouTubeRead
Simple Numbers, Straight Talk, Big Profits!
Greg Crabtree, met Beverly Blair Harzog · 2011 · ISBN 9781608320561
Where the Labor Efficiency Ratio comes from, with the market salary for the owner and the wage cost ceiling. 178 pages, American examples. Not translated into Dutch.
View the bookApply it
- 1
1. Get last year's figures
Revenue, cost of sales without wages, and the wage costs per person including holiday pay, employer's contributions and pension. Your own salary at market rate, even if you pay yourself less.
- 2
2. Split your people into direct and indirect
Direct is anyone doing client work. If someone spends half their time on clients, put half their wages under direct. Contractors doing client work count as direct wages.
- 3
3. Work out the two ratios
dLER is gross profit divided by direct wages. Management LER is gross profit minus direct wages, divided by indirect wages. Compare the dLER with the benchmark for your sector.
- 4
4. Work out your wage cost ceiling
Gross profit divided by your sector's benchmark is the direct payroll your current gross profit can carry. If you're below it, there's room. If you're above it, gross profit has to grow first.
- 5
5. Work out a new hire beforehand
What will the new employee cost per year, and how much gross profit do they need to bring in to keep the ratio level? That's their wage costs times the benchmark. Estimate how many months it'll take them to get there.
Examples
The calculation: a marketing agency with thirty people
Revenue €3,600,000, cost of sales €600,000 (media and production recharged to clients). Gross profit €3,000,000. Direct wages: 22 people in delivery, together €1,430,000 including employer's contributions and pension. Indirect wages: 8 people (senior leadership on market salaries, sales, office), together €640,000. Other operating costs €450,000. dLER: €3,000,000 / €1,430,000 = 2.10. The benchmark for marketing is 2.0, the threshold 1.5. Within target. Contribution margin: €3,000,000 minus €1,430,000 = €1,570,000. Management LER: €1,570,000 / €640,000 = 2.45. EBITDA: €1,570,000 minus €640,000 minus €450,000 = €480,000. Labour cost ratio: €1,430,000 / €3,600,000, so 40 cents of every euro of revenue goes to direct wages. Revenue per FTE: €3,600,000 / 30 = €120,000. The average in the advertising and market research sector is €194,680 per person employed (Eurostat, 2024), but that includes media agencies reselling advertising space. Here the dLER tells you more.
Four people hired at once
The agency expects growth and takes on four people in January, each costing €65,000 in wages. Direct wages go up to €1,690,000. Revenue grows by €300,000 that year, with €50,000 more cost of sales. Gross profit €3,250,000. dLER: €3,250,000 / €1,690,000 = 1.92. Below the benchmark, above the threshold. EBITDA: €3,250,000 minus €1,690,000 minus €640,000 minus €450,000 = €470,000. Revenue went up by €300,000 and profit went down by €10,000. Wage cost ceiling: €3,250,000 / 2.0 = €1,625,000 in direct wages. The agency is €65,000 above it: one employee more than its gross profit can carry right now. To keep the ratio at 2.0, each new employee has to bring in €65,000 × 2.0 = €130,000 gross profit a year. At a rate of €95 an hour, that's almost 1,370 billable hours.
What to do with a low dLER
Three levers, checked in this order: price (has your rate stayed the same for two years while wages went up?), utilisation (how many of your people's hours really go to clients?) and team size (do you have more people than the work needs, or the wrong mix of junior and senior?). Stop hiring until the ratio is back, unless the work's already sold.
Do this in your own business
Everything up to here is free. What you fill in for your own business, you keep in Boldcaster.
- Go to Value development. Value development shows your dLER next to the benchmark for your sector, with the labour cost ratio as a sentence underneath. The figures come from your latest valuation; enter your direct labour costs there, counting only the people who do client work.
- You assign the lesson to your team and see who has done it.
- The quiz counts towards your progress, and you see which lesson comes next.
Four weeks free. You'll land straight in this lesson.
Quiz
6 situations. You need 5 of 6 right. You can try again at any time.
1.A wholesaler has revenue per FTE of €400,000, a consultancy €150,000. What can you conclude about how productive their people are?
2.An owner works full time in delivery and pays himself €40,000 a year, while a replacement would cost €90,000. How do you include him in the dLER?
3.Your dLER is 2.1 against a benchmark of 2.0. You want to hire three people for a client who starts in four months. What do you expect this year?
4.A consultancy has €2,500,000 gross profit. The benchmark for consultancy is 2.5. How much direct payroll can that gross profit carry?
5.An IT company hires six freelancers (zzp'ers) for client projects and books them as cost of sales. The dLER is 2.6. What do you say?
6.At an installation company the dLER drops from 1.9 to 1.5 in two years. The team is the same size and everyone's busy. Where do you look first?
Nothing is saved here. In the app, the quiz counts towards your progress.
Read next
- Budget, forecast and actuals · You know what your budget, forecast and actuals each do, you build your revenue from capacity, utilisation and rate, and you can explain a variance line by line.
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