Why is accurate accounting important to you as a business owner? Besides the regulatory benefits of having accurate books for tax filing (which is certainly essential), accurate accounting is a core and necessary piece of making profitable business decisions.

How to make more profitable business decisions using accurate accounting – Measuring Labor Efficiency

For most firms in the professional services industry, the most significant core driver of revenue, cost, and ultimately bottom-line profit is people. From a financial perspective, it is critical to understand how people FUNCTION within your team, to analyze past results, forecast accurately, and plan future results.

Once the people function is understood, then you can financially organize the team into specific areas to measure month-to-month labor efficiency. Labor efficiency, in turn, is the best financial measure of how well the people on your team are driving profits. 

One step you can take right now to better measure labor efficiency:

If you’re starting from step 0 running your business and want to get to a place where you’re measuring Labor Efficiency consistently each month, the explanation above may give the impression that successful implementation is out of reach. However, there is one step you can take right now to start measuring labor efficiency (with the added benefit of enhancing strategic planning).

• Step 0: I know I said “one step,” but this step doesn’t count because it applies no matter what business financial goals you have: make sure your business has accurate Financial results! If you’re unsure or want to learn more about our philosophy, we can help. Regardless, a business must have accurate transactional bookkeeping and financials to gain benefit from measuring ANY KPI such as Labor Efficiency, because otherwise, you will have no assurance the numbers you’re analyzing and using for decisions are correct.

• Step 1: With Step 0 out of the way, you can move to the one step to better measure labor efficiency: Identifying your Direct and Administrative teams and categorizing them appropriately (and separately) on the Profit & Loss Statement (P&L). The key to measuring Efficiency is separating your DIRECT revenue and cost-driving team from your support ADMIN team. Both groups are equally important to business success. However, your Direct team is inextricably linked to and drives revenue, and so can be shown as a direct Cost of Sales that determines Gross Profit, while your Admin team is an overhead item for purposes of the P&L, and its cost is determined by the specific setup needs of your business. In other words, to get an apples-to-apples measurement of Gross Profit every month, you need to separate the Direct team from the Admin team because they have unique cost behaviors in relation to Revenue.

A quick example for context: Say you own a small company in the professional services industry that offers therapy to others. The company has one therapist (paid a set rate per session) and one billing admin. The therapist would be your Direct team because each session the therapist completes is translated directly to revenue (and labor cost). At the same time, the billing admin would be your Admin team because regardless of how many sessions the therapist completes, the admin will be there. So as revenue goes up, the therapist cost goes up (as they are billing more and logging more session hours) while the billing admin cost stays consistent (it doesn’t matter what amount is billed, the admin will be there for a set number of hours per week regardless). This is a simplified example, but the theory holds true in practice: direct labor drives revenue directly, which is different from admin labor. The two should be separated on the P&L to make better business decisions (which in turn means better cash flow and more cash in your pocket).

How to set up labor categories to bookkeep automatically and accurately using Gusto: Utilizing our preferred Payroll and HR partner, Gusto, you can easily set an automatic integration to import labor categories as desired directly into the accounting file. Here is a How-To article to get started. I also recommend contacting us to expertly set this integration up and accurately maintain it for your business!

By Kyle Smith, CPA