Is One Number Throwing Off Your #1 Key Performance Indicator?

by Corey Philip
December 9, 2017

KPI (Key Performance Indicator)

Your key performance indicator should measure how effectively and efficiently your company is reaching the goals that you set.

Do you know your most important KPI?

In my home services company, where the largest expense is often payroll, and a few poor decisions can result in a few wasted days, the most important KPI I’ve found is the labor efficiency rate.

If that number isn’t right, it can throw off my entire business. So, let’s take a look at what your labor efficiency rate is, how to calculate it, where it should be, and how to avoid allowing it to get out of control.

[For other good financial management tips I suggest this post]

What is the Labor Efficiency Rate?

So, what is your labor efficiency rate?

Your labor efficiency rate basically measures how you’re using your labor against what you’re paying for it (in addition to other costs).

To calculate your labor efficiency rate, you can use the following formula:

  • (total work completed) / (operations labor + payroll taxes and worker’s comp) = Labor Efficiency Rate.
  • Example: Lets say we complete $100,000 worth of work. We have to cut $30,000 in checks to our guys.  Now in my trade, we pay 42%($12,600) of payroll to worker’s comp (wc), and payroll taxes are about 15% ($4,500). $100,000 of work completed / $47,100 of operations labor = 2.12

In my experience, I’ve found that aiming for a labor efficiency rate of 3 is the optimal level in the home services industry.

However, 3 is pretty difficult to achieve.  If you’re ever falling below a 2, you’re going to run into several problems and may not be in business for long.

Common Mistake That People Make

When people are calculating their labor efficiency rate, I often see them making the same mistake.

In the home services industry, contractors usually take deposits but don’t actually complete the work for several weeks or months. However, when they take a look at their books at the end of the month, they often report all of that cash that they received in deposits as revenue despite not having the work complete.

This is also known as cash basis accounting. Let’s take a quick look at cash basis accounting and accrual accounting so that you can better understand what I’m about to say.

  • Cash Basis Accounting: When someone uses a cash-based accounting system, they count revenue as money is received and expenses when they are paid. When using this method, you don’t recognize accounts receivable or accounts payable.
  • Accrual Accounting: Accrual accounting differs from cash basis accounting in that you record your revenues and expenses when they are earned. It doesn’t matter when you actually receive the money.

The problem that people run into when they work on a cash-based accounting system is that it distorts things when analyzing numbers like the cost of goods sold and labor efficiency because the cash coming in could be mostly deposits and not indicative of actual revenue earned.

However, you don’t necessarily have to switch all the way over to an accrual accounting system if you’re already using cash basis accounting.

Your labor costs; wages, wc, and payroll taxes, can’t be put on credit (at least not easily), so the numbers in your cash basis accounting systems will be nearly accurate – especially if you’re issuing payroll weekly.  For total work completed DO NOT use the cash number that your account program spits out in the income statement.  It’s certainly easy to use it as the number is already there, but instead, manually get the  ‘total work completed’ (aka the revenue that you earned) from your CRM, field service management software, or calculate it out. Use that as the top line number!

Keeping Your Labor Efficiency Rate Strong

For me, my labor efficiency rate has always been my most important KPI.

It’s a super easy way for me to sit down, calculate a quick number, and instantly be able to take the pulse of my business. As long as you’re honest with yourself and with your books, your labor efficiency rate will tell you a lot about how you’re doing. Calculate it now, month by month.  If you see a consistent trend of the number below 2, you quickly need to make some changes, either cutting down on labor, increasing pricing, or using your labor more efficiently.

About the author

Corey Philip

Corey Philip is a small business owner / investor with a focus on home service businesses.

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