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- How I Saved My Business with LER
Welcome back to The Small Business Mentor!
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Let’s dive in…
This week on the pod, the small business mentor had his own small business mentor on, Greg Crabtree.
This guy is a titan. I found Greg when I was at one of my lowest points in business.
We were losing money and piling up debt on our line of credit. As a result, I wasn’t sleeping well and had plenty of time to cruise YouTube in search of answers.
Late one night, I found one of Greg’s talks that focused on the importance of labor to your business.
You might not think this is a stunning insight but for me it was as if the heavens had opened and a ray of truth illuminated the dark night.
What I realized was that we were floating people we had no work for and the sooner we confronted that reality, the better it would be for us.
Of course, we sort of knew that already but what Greg made clear is that the numbers were letting us lie to ourselves.
Go look at your own profit and loss statement. You’ll see labor spread across multiple accounts. That P&L was developed to pay your taxes, not help you run your business.
If a number is important it shouldn’t require you to hunt and peck to find its components and add them all up. It should be staring you in the face every day.
That was Greg’s fundamental insight.
Labor is almost every company’s biggest investment/expense so you should focus on managing it and using the right metrics to measure it.
That’s where labor efficiency comes in. It’s a North Star metric for almost any business. Greg calls his metric the Labor Efficiency Ratio (LER).
Here’s how you calculate it. First, add up all the labor accounts across your P&L. That’s your Total Labor Cost.
Now here’s the two step formula:
1) Revenue-direct costs1 -subcontractors=Gross Margin.
2) Gross Margin/Total Labor Cost=LER.
What’s amazing is that almost every company will get around a 2 LER.
Freaky right?
If you are way above a 2, congrats, you must be running Facebook. If you are way under, God bless you because you are working for no profit.
Next week I’ll break down the components of LER that can help you get a better feel for how your business works and which areas of your business you need to focus on to get better. Until then…
Keep growing,
Alan
1 Direct costs are things like materials or travel you use to directly serve a customer. Subcontractors are companies or 1099 consultants who truly work independently. If a 1099 is really managed by you, then they count as direct labor. You’ll also see that most people will refer to Gross Margin as what’s left over after you subtract out direct costs, subs, and direct labor but we are using it differently here.
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