Several years ago, a small business prospect asked me about their idea of employing a new sales person. At that time, the company’s industry was high sales with low margins. This prospect were being crowded out by the big home technology manufacturers who can work at a much higher sales volume. This company’s gross profit margin was 6%. However, to increase their market share, they wanted to hire a sales person for $60,000. I explained quickly that the sales person would have to bring in $1,000,000 of sales just to break even on the new employee’s salary. This does not count the additional costs like worker’s compensation insurance, payroll taxes, vacation pay, etc.
Now, when you add up all of the relative costs, including sick pay, you have the true cost of the employee. If you divide that by the hours it takes an employee to perform a function, you arrive at your “burden rate.”
Small businesses must do this type of analysis before strategizing to hire new bodies. Other considerations are discussed in How to figure out the actual cost of your employees by Ken Kaufman.
Kaufman’s article eludes to the burden rate per employee, but this analysis sometimes is harder to produce in manufacturer settings. For example, if you have an employee that designs multiple products, you would have to quantify the hours the employee spends on each design. That may sound easy unless that employee moves between products in one day.
This kind of analysis will be valuable to a small business in setting prices, budgeting and forecasting, and expanding. However, where small businesses handicap their information is in business plans. A venture capitalist or entrepreneur should start at the granular data of an employee’s burden rate. Once you know that, you can project the production efficiency and work your way to pricing the item based on a gross profit ratio. Lastly, you can project your units and arrive at forecasted sales.
What a small business entrepreneur will find out from this strategy is whether their pricing will be competitive in their respective market space. If not, they should know that before funding a small business.