Fundamentals of Business

Employees can make or break the success of a business, and it is critical to hire the best employees you can afford.  Your employees will make thousands of decisions that affect the profitability of the business, and there is a measurable financial cost to under-performing employees.  While there are many resources that talk about the cost of hiring employees and the total cost of their compensation, this blog post is not about those costs.  Our focus is on the cost of decisions made by employees.

To calculate an employee’s impact on profitability, you will need to measure their performance, take action to make improvements, and measure again.

Step 1: Measure Performance

Establish financial performance goals within the first 30 days of hiring an employee.  The goals should be specific and measurable for how the employee’s position impacts revenue and/or expenses.  Here are three examples:

• • An Agricultural Ranch (Production) Manager is responsible for producing units without going over budgeted cost. The employee’s impact can be measured by multiplying the unit variance to budget by the actual profit margin per unit.  Over/under spending can be measured by calculating the cost per unit variance to budget multiplied by the actual total units produced.
  • An Admin Manager is responsible for staying under budget on staffing the department. This can be measured by comparing actual expenses versus the budget.  They could also be responsible for providing timely analyses to a Production Manager which would have an impact on hitting or missing production and cost goals.  The Admin Manager would then share accountability for a reasonable portion of the Production Manager’s goals.
  • A Sales Representative is responsible for generating sales to new and existing customers. Similar to a Production Manager, performance can be based on the profitability of each sales order.  Multiply the number of units for each sale by the actual profit margin per unit.  This calculation could also be applied if the Sales Rep loses customers.

Management will need to decide what financial goals are appropriate for each position.  Historical results are a great guide for goal setting.  If you have personal prior experience performing the same type of work, you can set the goals based on your own rate and record.

Step 2: Take Action

Set a schedule for evaluating the performance results and take action as needed.  This review could be weekly, monthly, quarterly, or annually as appropriate for each goal.

It is easy if the employee meets or exceeds expectations.  You can reward them and celebrate their accomplishment.  The reward should be commensurate with the goal, and you can consider giving them a bonus, extra paid time off, or some other perk.

If the employee did not meet expectations, then corrective action must be taken.  Sometimes it is simply that the employee does not fully understand the detailed steps that they are supposed to do.  Common reasons for underperformance are the employee’s lack of skills and training.  It is important to get to the root cause.  Management must then consider corrective training, counseling, or coaching based on the situation.

At this step, another common error is avoiding conflict or waiting too long to address the problem.  This will potentially spread the problem to other employees because they will see no consequences for underperformance.  It then becomes a downward spiral with employee morale and worsening performance.

Do not create extra processes to compensate for an underperforming employee.  Although this is tempting to do, it rarely helps the employee improve their performance.

Step 3: Measure Performance Again

Use the results of Steps 1 and 2 to measure performance again.

For employees who have continued to meet or exceed their performance goals, use the established schedule to check results and provide feedback.  If they consistently do well over a period of time, consider elevating the employee to the most senior position among their peers or promoting them.

For employees who need to improve, check their results more frequently.  You may need to escalate the response depending on the results.  This could include more severe actions such as demotion or termination.

Other intangible factors may affect your decisions.  Does the employee have a positive attitude and are they motivated?  Or does the employee have a negative attitude that impacts other employees?  Look at the whole picture when evaluating performance and next steps.

It is important to measure each employee’s impact on profitability and to act as needed.  With this information, you can determine the benefit or cost of each employee and if you have the right employees on your team.  Mostly importantly, act in a timely manner.  With consistent observation and review, your business will maximize its performance and be successful.

Spectrum Small Business Advisors is here to help. Contact James Gargiulo at (949) 351-1538 or James@SpectrumSBA.com for assistance with your business.