Compensation management is the process of reviewing salaries and benefits, researching market trends, and comparing an organization’s pay practices to its competitors. Compensation metrics are an integral part of compensation management, pulling together important pay data to monitor and analyze.
Although several compensation metrics exist, your organization probably won’t need all of them. Some are better than others for specific types of compensation that your company might not use, for example.
Regardless of the metrics you use, you’ll quickly understand their importance in managing payroll. The right metrics can help you define a payroll budget, close wage gaps, and find payroll inconsistencies that could lead to employee dissatisfaction and unfair pay.
In this guide, I outline a few of the most common compensation metrics for controlling payroll that could benefit most businesses.
1. Payroll to Revenue Ratio
Payroll to revenue outlines how much of your revenue goes directly toward your payroll, which can identify whether you have room to expand your payroll budget or need to cut labor costs.
For example, suppose a small business had $500,000 in gross revenue and a payroll of $100,000 in 2022. That company’s payroll to revenue ratio was 1:5, or 20%.
Although there’s no magic payroll to revenue number that works for every company, it’s smart to shoot within the range of 10% to 30%, meaning that no more than 30% of your organization’s revenue should go toward payroll.
Now, some companies prefer to use their net revenue rather than gross revenue in determining payroll to revenue ratio. This can benefit startups with significant expenses as they scale their businesses, for example. However, the metric usually refers to gross revenue, offering a more precise picture of a company’s direct revenue allocation to payroll.
Consider using this metric when comparing payroll at your company to that of competitors with similar revenue to determine where you stand regarding employee compensation.
2. Target Percentile
Target percentile denotes where you’d like your company’s salaries to fall compared to their market rates. As an example, if your target percentile is 80%, you want to pay at least 30% above the market rate, which aligns with a target percentile of 50%.
The first step in determining your target percentile is defining a salary range midpoint. This process finds a midpoint between salaries for similar roles, such as all mid-level accounting positions. Your salary midpoint is a good number to compare to market rates to see whether you’re close to your target percentile.
I’ll illustrate how we do this at Stone Press. As a remote company, we have people from all over the country work with us, which also means they experience different living costs.
Therefore, we compare our salary midpoints to salary midpoints in high-pay areas like New York City. This allows us to offer the same salary structure to all new hires for a particular role without worrying about cost of living adjustments based on where employees live.
As a company that prefers leading the market, we always shoot for a target percentile above 50% when comparing our salary midpoints to market values for salaries in high-pay areas.
3. Pay Ranges
Target percentile becomes helpful in determining pay ranges. A pay range includes the minimum and maximum amounts your company pays for a role. This sets clear salary benchmarks for each position, allowing employees to know what pay they can expect based on their experience and performance.
Say that with your target percentile set at 10% market value (a 60% target percentile), you determine that the salary midpoint for a financial consultant at your company should be $100,000.
Now, consider how much you believe a salary range should spread for that position. For example, a 40% range spread would allow a 40% difference between minimum and maximum pay for financial consultants.
To calculate the minimum range point, also known as the starting salary, you’d divide the salary midpoint by 1 plus the salary range of 40% divided in half, or 1.2. So, the starting pay would equal $83,333 ($100,000 / 1.2).
Now, to calculate the maximum range point, you take the starting salary of $83,333 and multiply it by 1 plus the salary range, or 1.4. This makes the maximum salary point $116,666.
Rather than assigning the same pay range to every position, it usually works best to assign varied pay ranges. For example, administrative roles might require lower ranges around 20%, while management roles might warrant broader ranges of 40% to 50%.
4. Compa Ratio
Short for compensation ratio, a compa ratio compares a specific employee’s salary to the midpoints of salaries for similar roles in your company or market values for similar roles. As you might guess, using this metric is an excellent way to evaluate whether you’re paying employees fairly and if you might need to adjust your payroll budget to accommodate better compensation.
Let’s look at an example of using compa ratio to determine where an employee’s salary falls.
Mark earns $60,000 a year, and you determine that the midpoint for similar roles within your company is $70,000. $60,000/$70,000=0.85 or 85%. Now, if the midpoint for similar roles in other organizations is $55,000, the compa ratio becomes 109%.
In this example, Mark earns 15% less than the midpoint salary in your company but 9% more than similar roles in competing organizations. From this, we could conclude that your company gives employees like Mark higher than average pay.
It’s generally best to target between 80% and 120% when using compa ratio. However, some companies use different ranges to increase salary based on performance. As an example, Mark might start with 70% as a new hire but has the potential to increase his salary by up to 5% of market value with each performance evaluation.
5. Market Ratio
While compa ratio compares salaries to midpoints of salaries for similar roles, market ratio compares salaries with their average market salaries. This metric allows companies to specifically compare their salaries to external data, an important practice for determining fair pay and payroll budget.
Market ratio is calculated by dividing a person’s salary by the average market value for that or a similar role. For example, a salary of $100,000 compared to a market value of $110,000 would have a market ratio of 91%. If the market value was $90,000, the market ratio would be 101%.
6. Salary Range Penetration
Salary range penetration highlights where an employee’s salary falls within a salary band. In other words, does the employee’s salary land closer to the minimum or maximum ends of their position’s salary band?
This metric can help you see whether most of your employees still have lots of room within their salary bands for raises, allowing you to plan your payroll budget for the future.
To find salary range penetration, you subtract an employee’s salary from their salary range’s minimum number. Then, divide that total by the difference between the salary range’s maximum and minimum numbers.
Say Beth earns $80,000 a year. Her salary band ranges from $60,000 to $90,000.
To calculate Beth’s salary range penetration, you’d subtract her salary, $80,000, by the salary range’s minimum, $60,000, which gives you $20,000. Then, subtract the maximum and minimum numbers from the salary range: $90,000 – $60,000 = $30,000.
Now, divide the first number by the second number: $20,000/$30,000 = 67%. This number typically reflects the salary of an above-average employee, whereas top performers are typically closer to the 80%+ range. Meanwhile, new hires might be closer to 30% or below.
7. Employee Turnover Rate
An employee turnover rate is a calculation of the proportion of people who leave the company compared to the number of employees. High employee turnover rates can be incredibly costly for businesses. They can also indicate that the company isn’t meeting employee expectations, whether those expectations are related to pay, a welcoming work environment, or professional development.
Most companies should target a turnover rate of 10% or less. By reducing employee turnover, companies can effectively reduce turnover-related costs that eat into their payroll budget.
To calculate employee turnover rate, divide the number of employees who have left the company for a period—usually quarterly—by the number of people who were employed at the start of that period. For example, a period starting with 50 employees during which two resigned would have a turnover rate of 4%.
Keep Your Payroll on Track
Payroll management doesn’t end with calculating the metrics I detailed here. Instead, it’s a constant process that requires new data and calculations on a regular schedule. Reevaluate your payroll budget each year to make sure it still works for your company and its employees.
To help with payroll, I suggest using a payroll service that can assist with tax management, payment processing, payroll documentation, and more. By saving time on tedious payroll tasks, you can devote more time to evaluating and improving your pay practices and payroll budget.
