The Problem That Will Not Die
46 Construction Equipment Distribution www.cedmag.com December 2009 Payroll expense is like a character in a cheap horror movie it's frighten-ing and just when it seems to have been vanquished, it turns up in a sequel. Well, just like in the movies, payroll expense is back. This time the sequel is due to sales challenges asso-ciated with the recession. Sales have disappeared a lot faster than reduc-tions in payroll expense can be made. This report will examine the impact that payroll expense is having on industry profit perfor-mance and how that performance can be brought back in line with desired payroll levels. It will do that by addressing two key issues: n Assessing the Payroll Challenge An explanation of the most effective way to evaluate payroll productivity n The Economics of Payroll Control An examination of the alternative approaches available to manage-ment to lower payroll expenses Assessing the Payroll Challenge There are numerous ways to evaluate payroll, including sales per employee, payroll as a percent of sales, or payroll per employee. However, none of these ratios provides as complete an examination of the firm's ability to control payroll as the Personnel Productivity Ratio (PPR). The PPR, which is reported each year in the CODB Report sponsored by AED, expresses total payroll expense as a percentage of the gross margin dollars generated by the firm. Total payroll expenses include all employee compen-sation and all fringe benefits. The ratio is not intuitive, so it is useful to start with a look at some of the key financial results for the typical AED member: n Net Sales: $35 million n Gross Margin: $7,525,000, or 21.5 percent of sales n Payroll: $3,867,850, or 11.1 percent of sales n PPR: 51.4 percent ($3,867,850 of payroll divided by $7,525,000 of gross margin) The PPR is one of the rare ratios where lower is better than higher. For AED members, the ratio means that every dollar of gross margin gener-ated requires a payroll expenditure of 51.4 cents. This means that after paying all payroll expenses, there is only 48.6 cents left to cover all of the firm's other expenses and generate a profit for the firm. The strength of the PPR is that it reflects the overall impact of three different profit pressure points: sales, payroll itself and gross margin. However, this advantage is also something of a disadvantage. Sometimes it is difficult to determine which of the three different pres-sure points should be addressed: n Sales Volume If additional sales can be generated with the same gross margin percentage and the same dollar commitment to payroll, then the PPR will fall. n Payroll Costs Any cut in payroll that does not result in a reduction in sales will clearly lower the PPR. n Gross Margin If the firm increases its gross margin percentage on the same sales volume, the PPR will also fall. In most instances, management uses a blend of actions to bring down the PPR. What is most important to remember is that any group of actions that lowers the PPR will simultaneous-ly generate higher profits for the firm. The Problem That Will Not Die It's perhaps the most emotionally charged issue in your business, yet the payroll monster continues to rear its ugly head. This `Profit Improvement Report' features a formula for balancing personnel costs against sales. By Dr. Albert D. bAtes (continued on page 48)