Investment analysts use a variety of key ratios, such as return on equity (ROE), return on assets (ROA), and price-earnings ratio (P/E), to gauge a company's well being. One number that doesn't get a lot of attention is the sales-per-employee ratio. While it does have its limitations, this ratio does give investors some sense of a company's productivity and financial health.

What Is the Sales-per-Employee Ratio?
The name indicates how the sales/employee ratio is calculated: a company's annual sales divided by its total employees. Annual sales and employee numbers are easily located in published statements and annual reports.

The sales-per-employee ratio provides a broad indication of how expensive a company is to run. It can be especially insightful when measuring the efficiency of businesses such as banks, retailers, consultants, software companies and media groups. "People businesses" lend themselves to the sales per employee ratio.

Interpreting the ratio is fairly straightforward: companies with higher sales-per-employee figures are generally considered more efficient than those with lower figures. A higher sales-per-employee ratio indicates that the company can operate on low overhead costs, and therefore do more with less employees, which often translates into healthy profits.

Consider the software maker Qualcomm. In 2003, the company generated $690,000 in sales per employee. By comparison, software giant Microsoft generated about $500,000 in sales per employee. This suggests that Qualcomm is making more of its workforce and demonstrates why the stock market consistently awards Qualcomm a higher valuation than other technology stocks.

Compare Apples with Apples
The sales-per-employee ratio is best used to compare companies that are similar. Retailers and other service-oriented companies that employ a lot of people, for instance, will have dramatically different ratios than software firms. For example, Starbucks Coffee is a highly efficient retailer, but because it employs nearly 74,000 full and part-time staff, its sales-per-employee figure of $55,000 seems to pale in comparison to Qualcomm's $690,000 per employee.

Companies that concentrate on selling and distributing products will typically enjoy much higher sales-per-employee figures than firms that manufacture goods. Manufacturing is typically very labor intensive, while sales and marketing activities rely on fewer people to generate the same sales numbers. In manufacturing, each employee can usually assemble only a certain number of products. Increasing production requires more employees. By contrast, marketing and sales activities can increase without necessarily adding staff. Take the sports footwear maker Nike: since making the decision to outsource its manufacturing to other companies, the firm's sales-per-employee ratio has skyrocketed.

Early-stage businesses typically have low sales-per-employee numbers. Companies involved in developing new technology, for example, often have meager sales-per-employee figures in their early years. Sonus Pharmaceuticals, for instance, generated only $610 per employee in 2003. But the firm's sales-per-employee multiple will grow as its lead drug products, which are still in the trial stage, are expected to gain wider sales eventually.

You should also be careful about employee numbers stated in the financial reports. Some companies employ sub-contractors, which are not counted as employees. This kind of discrepancy can put a wrinkle in your analysis and comparison of sales-per-employee figures.

Trends Are Important
Be sure to watch sales-per-employee ratios over several years to get a reliable idea of performance. Don't jump to conclusions without examining trends over time. A jump in sales-per-employee efficiencies can be just a blip. For instance, big job cuts often translate into a temporary ratio boost as remaining employees work harder and take on extra tasks. But research shows such a boost can quickly reverse as workers burn out and work less efficiently.

A steadily rising sales-per-employee ratio can mean a number of things:

• increasingly streamlined organizations;
• recent capital investment that improves efficiency;
• great products that are selling faster than those of competitors.

Also, a company that consistently generates rising sales with a stable or shrinking work force can usually boost profits more rapidly than one that can't make additional sales without adding more workers. An improving sales-per-employee ratio frequently precedes growth in profit margins. A climbing sales-per-employee number could mean that the company is growing but has not hired more employees to handle the added workload.

Again, be careful. If numbers change dramatically, it's worthwhile to take a closer look.

Conclusion
Although you need to be careful when using this ratio, you can tell a lot about a company and its future from its sales-per-employee figures. Investors can get a quick sense of the company's financial health and of how the company fares against its peers. While the ratio doesn't tell the whole story, it certainly helps.

Related Articles
  1. Economics

    Why Enron Collapsed

    Enron’s collapse is a classic example of greed gone wrong.
  2. Investing Basics

    Corporate Dividend Payouts And the Retention Ratio

    An investor can use dividend payout and retention ratios to gauge an investment’s possible return, and compare it to other stocks.
  3. Investing News

    How Banning Buybacks Would Help the Economy

    Stock buybacks are popular, but they're not helping the economy. Here's what would happen if they were banned.
  4. Economics

    How Leadership Impacts Investments

    Investors often overlook a company’s leadership when evaluating an opportunity, but it’s an important quality to consider.
  5. Economics

    Explaining Incorporation

    Incorporation is the process of legally becoming an entity that is separate from its owners.
  6. Economics

    What is a Firm?

    A firm is a business or organization that sells goods or services on a for-profit basis.
  7. Professionals

    The Path To Becoming A CEO

    Think you have what it takes to be chief executive? Find out what those at the top have in common.
  8. Investing

    Hostile Takeover

    A hostile takeovers is an unfriendly acquisition attempt by a company or raider that is strongly resisted by the management and the board of directors of the target firm. Learn more about the ...
  9. Investing Basics

    What are the fiduciary responsibilities of board members?

    Find out what fiduciary duties a board of directors owes to the company and its shareholders, including the duties of care, good faith and loyalty.
  10. Economics

    What's a Horizontal Merger?

    A horizontal merger occurs when companies within the same industry merge.
RELATED FAQS
  1. How do modern companies assess business risk?

    Before a business can assess or mitigate business risk, it must first identify probable or likely risks to its bottom line. ... Read Full Answer >>
  2. Why has emphasis on corporate governance grown in the 21st century?

    Corporate governance refers to operational practices, management protocols, and other governing rules or principles by which ... Read Full Answer >>
  3. What impact did the Sarbanes-Oxley Act have on corporate governance in the United ...

    After a prolonged period of corporate scandals involving large public companies from 2000 to 2002, the Sarbanes-Oxley Act ... Read Full Answer >>
  4. Why should investors research the C-suite executives of a company?

    C-suite executives are essential for creating and enacting overall firm strategy and are therefore an important aspect of ... Read Full Answer >>
  5. What is the difference between a direct and an indirect distribution channel?

    A direct distribution channel is organized and managed by the firm itself. An indirect distribution channel relies on intermediaries ... Read Full Answer >>
  6. How can an investor determine a company's annual return from looking at its financial ...

    The funds in a share premium account cannot be used for a company's general expenses. These funds are restricted in terms ... Read Full Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  6. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
Trading Center