Hire when your labor efficiency ratio says your people are stretched, not when the phones feel busy. The labor efficiency ratio, or LER, is gross margin divided by the wages of the people who actually deliver your work. It tells you how many dollars of margin each dollar of frontline payroll produces. Track it every month against your own baseline. When it climbs well above normal and the overtime is piling up, your team is probably carrying more than it can sustain, and a hire will likely pay for itself. When it slides below normal, you already have more labor than your margin supports, and another hire makes the problem worse.
Most owners make hiring decisions on feel. Everyone is working Saturdays, a big job just landed. Those are real signals. They just don't tell you whether the business can afford the next person, or whether the real problem is pricing or a job that's bleeding hours.
Why "we're busy" is the wrong trigger
Busy is a feeling. Margin is a number. A shop can be slammed and still losing ground, because the work it's buried in is underpriced or poorly run. Adding a person to that situation just adds payroll to a problem that payroll won't fix.
Hiring is also where growth usually starts to bite. The day someone starts, their wages hit your margin. The revenue to justify them shows up later, if it shows up at all. That gap is why I keep saying growth and scaling are not the same thing. Scaling is maintaining that same profit margin as you grow. (The longer version of that argument is here.)
The labor efficiency ratio, in plain English
The metric comes from Greg Crabtree, a CPA and author of Simple Numbers, Straight Talk, Big Profits! The direct-labor version works like this:
LER = Gross margin ÷ Direct labor wages
Two definitions matter, and most P&Ls don't line up with them out of the box.
Gross margin here means revenue minus your non-labor costs of delivering the work: materials, parts, and subcontractors. Your own employees' wages are pulled out and measured separately. That's the whole point. Labor is the cost you manage most directly, so it gets its own line instead of being buried in cost of goods sold.
Direct labor means the wages of the people who deliver what you sell. Field crews and technicians in the trades. Providers and clinical staff in a medical practice. Billable staff in a professional firm. Crabtree's guidance is to use wages only, leaving payroll taxes and benefits out, and to count anyone who spends at least half their time doing the work as direct labor, even if they also manage.
The result reads simply. An LER of 2.4 means every dollar of frontline wages produces $2.40 of gross margin. That margin has to cover your managers, your rent, your overhead, and your profit.
What the number is telling you
You'll see published benchmark ranges for LER by industry, and they're worth a look. But Crabtree's own advice is to judge the ratio as a trend against your own trailing twelve months, not as a snapshot against someone else's average. Your baseline reflects your pricing, your crews, and your customers.
Once you have that baseline, the ratio moves in one of two directions, and each one means something different.
It's climbing well above your normal. Your team is producing more margin per wage dollar than it historically has. Sometimes that's real improvement, like better pricing or less rework. But if it comes with overtime, missed deadlines, and tired people, it usually means you're running hot. An exit-planning advisor we had on the NextGen Strategies podcast made exactly this case for tracking the ratio monthly: it flags an overworked team before it turns into a retention problem. Losing a trained employee to burnout usually costs more than the hire you put off.
It's sliding below your normal. You're paying for more labor than your margin supports. Before you hire anyone, find out why. Common culprits are underpriced work, a job running over its hours, people waiting on materials, or a recent round of hiring that the revenue hasn't caught up to yet. A short dip right after new hires is normal while they get up to speed. A slide that keeps going is not.
Run the hire before you make it
Here's where the ratio earns its keep. These are round illustrative numbers, not a client.
Say a specialty contractor does $3,000,000 in revenue. Materials and subcontractors run $1,200,000, so gross margin is $1,800,000, or 60% of revenue. Field wages are $750,000. The LER is 2.4.
The owner wants to add a technician at $60,000 in wages. To hold the ratio at 2.4, that person needs to bring in $144,000 of additional gross margin ($60,000 × 2.4). At a 60% gross margin, that's $240,000 of additional revenue.
Now the question is concrete. Is there $240,000 of work you're turning away, delaying, or doing on overtime right now? If yes, the hire likely pays for itself. If you're hoping the new person will help you find that work, you're not making a hire. You're making a bet, and it's worth knowing that before payroll starts.
Where owners get tripped up
Subcontractors versus employees. Crabtree's approach puts subcontractors in cost of goods sold, because you're paying them a price that includes their own profit. Whatever you decide, be consistent month to month, or the trend is meaningless.
The owner in the field. If you're running a crew yourself, your time is direct labor, and it should carry a market wage in the math. Leaving yourself out inflates the ratio and hides how much of the business depends on you. That dependence is also the top reason exit planners give for profitable businesses that can't sell.
Seasonality. Trades and many service businesses swing hard by season. Use a rolling twelve-month figure so a slow January doesn't trigger a panic.
Books that aren't set up for it. If your P&L lumps wages into one payroll line, you can't calculate this without first splitting direct labor from everyone else. That's a one-time cleanup, and it pays off in every hiring decision after it.
Where this fits
The ratio is one line on a monthly scorecard, next to cash, margin, and how you compare with peers your size. Its job is to put a number on a decision most owners make on instinct.
An accountant works on the past. Your CFO works on the future. Telling you, before you post the job, whether the next hire pays for itself in four months or fourteen is squarely CFO work, and it's the kind of work laid out in our process. If hiring decisions are getting bigger and the data behind them isn't, that's one of the signs you've outgrown doing it on feel.
FAQ
What is the labor efficiency ratio? It's gross margin divided by direct labor wages. It shows how many dollars of gross margin each dollar of frontline payroll produces. The metric was developed by CPA Greg Crabtree in his Simple Numbers work.
What is a good labor efficiency ratio? Industry ranges are published, but the most useful comparison is your own trailing twelve months. A ratio that holds near your baseline while you grow is healthy. One that keeps falling means labor is growing faster than margin. One that spikes well above it can mean your team is overstretched.
Should payroll taxes and benefits be included? In Crabtree's version of the direct labor ratio, no. Use wages only and keep taxes and benefits in operating expenses. Whatever method you choose, apply it the same way every month.
How do I use the ratio to decide on a hire? Multiply the new hire's wages by your current ratio to get the gross margin they need to generate. Divide that by your gross margin percentage to get the revenue required. Then ask whether that work already exists or whether you're hoping it will.
Does this work for a medical practice or professional firm? Yes. Providers, clinical staff, and billable professionals are direct labor, and supplies and outside services come out before gross margin. It works the same way in healthcare as it does in the trades.
If you're about to make a hire and you can't say what it needs to produce to pay for itself, that's worth a conversation. Talk to us and we'll run the math with you before payroll does.