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What is your business' salary cap number?

By Sean M. Hugo, CPA
Sports fans understand the concept of a salary cap as most of the major professional sports leagues have some version of a salary cap. What most sports fans that are business owners don’t think about is that their business could benefit from establishing a salary cap. 
 
For the non-sports fans out there a salary cap is the total salary a team/business can have for a period of time. How do you calculate what your salary cap should be? Let’s look at an example.   Assume you make widgets and you project sales to be $100 and it costs you $20 in COGS to produce the widgets you would have a gross margin of $80. Assume you want a profit of $30 after your deduct your general and administrative expenses (G&A) and salaries. This tells us we have $50 left we can spend between salaries and G&A. We know from past experience that G&A is $20 this means that our salary cap is $30. This means that salaries shouldn't be anymore than 30 cents for every dollar of sales.  Knowing this you can manage to this number. 
 
You could literally manage to the salary cap number hourly.  In fact, I bet you have been to businesses that manage to this number hourly have you eaten at Outback Steakhouse.  Management monitors the sales and if at 9:00 PM labor is above the salary cap they will send someone home that is an hourly worker to make sure they are at or below their salary cap number.  They find it is much easier to manage to the number than to try to increase sales the next day to make up for the overage the day before.  
 
If you would like more information on how you could take this idea of a salary cap and implement it in your business give us a call at the office.