Chapter II: Labor Cap   Helps Keep Your Business Profitable

Rick Phelps

Synchronous Solutions

Labor Cap   Helps Keep Your Business ProfitableRoger joined the Zoom call with Coach Rick, right at 10 am, a huge grin on his face.

“Good morning, Roger, what do you feel like expressing [WIFLE]?” Rick asked.

Roger remembered how odd and uncomfortable he had thought that question was when he had first started the on-going coaching program with Synchronous Solutions. How times had changed! Today he planning to start own leadership team meetings with a WIFLE.

“What I feel like expressing is, well, joy! We had another great month last month, the most profitable month yet again! Life is good, I am working less, stressing less, and yet…” Roger paused to gather his thoughts. “And yet I am feeling a bit anxious. Business is up, profits are up, and demand to add people is up, too. I guess I am worrying about growing too much and messing everything up.” Roger paused. “And that’s what I feel like expressing” he finally concluded.

“Thank you, Roger. What I feel like expressing is, I am grateful that you are now comfortable sharing what you are feeling. It really helps guide how I can help you navigate the growth of your business! And congratulations on yet another record month of profits! And that is what I feel like expressing!” was Rick’s response.

“Let’s jump right into it” continued Rick. “You are feeling under pressure to add staff and are worried about growing too much and losing your profitability. Am I understanding this right?”

“Yes, the front office is starting to feel overworked and are asking for help. Can I afford to hire additional people? Do I need to wait? How would I know? I guess I am just not comfortable with my numbers yet,” concluded Roger.

“Fair enough. Is adding a team member an investment or an expense?” was Rick’s follow-up question.

Roger paused. Rick always seemed to turn the their dialog back on him with a question. At first this had annoyed Roger, but now he saw how the questions made him think and understand things better. He liked having to work it out himself, now. 

“Alright, I know that on the Profit & Loss statement the new team member’s salary will show up as an Expense. So, it is an expense. However,” Roger continued quickly, “I also remember when I refused to hire the CNC helper because I couldn’t afford the expense, that was a HUGE mistake. Hiring him was the start of turning my company around. Hiring him may well have been the smartest investment I have ever made!”

Rick cleared his throat. “After hiring Synchronous Solutions, of course!” Roger quickly added with a laugh.

“Exactly! Well expressed, Roger! Let me summarize the two issues that I believe might be driving your unease. Number one: can you afford to hire an additional team member? Number two: is this the right place to invest in your business, at this time? Is there anything else driving your unease?” Rick asked.

“You actually described my angst very well!” Roger replied.

“Alright, let’s start with the first issue – can you afford to hire an additional team member at this time? Are you familiar with the concept of salary caps? It’s used in professional sports leagues like the NFL. Salary caps are used to keep the leagues competitive.”

“Well, I’ve heard of them, but don’t really follow sports all that closely,” Roger admitted. “How do salary caps work?”

“The sports leagues establish a maximum amount each team can pay their players every year. The idea is to keep the wealthier teams from always dominating through buying up all the best player’s contracts. Does it make sense that there might be a cap on how much you can afford to pay your team and still stay healthy and profitable as a business?” asked Rick.

“Of course it does! If I spend too much on my team, or too much on the wrong players, I won’t be competitive.”

“Well said, Roger! So, you have a maximum amount you can afford to pay for labor, whether it is what Bob, your accountant, refers to as Direct Labor, or Salary Labor, Overhead Labor, whatever. Labor is labor. It is time to show you a hidden part of your PCP tool, your Protective Capacity Planner (PCP). Let me share my screen with you, but open up your copy so you can follow along.”

Rick pulled up Roger’s PCP spreadsheet and opened it to the PCP tab, scrolling down to the section labeled ‘$T & FINANCIAL GOALS.’  “There is a set of rows hidden in this section,” Rick explained, while he unhid them, “that help you understand your LABOR CAP. Up until now, we have talked about $OE, Operating Expense, as a single entity. Labor is such an important part of any business we want to be able to examine it separately from all the other elements that make up OE. Here you can see your $OE is split into two parts – $OE Labor and $OE Other,” Rick explained.

“Wait a minute,” Roger protested. “This data has been hidden here all along?”

“Well, yes. We try not to overwhelm you with too much information, all at once. As it is, you have been drinking from a firehose of information this past year!”

“That’s for sure,” Roger agreed. “So you knew this would come up?”

“Roger, it is extremely common for businesses to grow their $OE too fast and damage their business, especially in the countertop industry. Again, it has its roots in the financial accounting system. Accounting tends to take what is fundamentally simple and makes it complex and confusing, leading to ‘justifications’ for buying labor or equipment difficult, and honestly, they are often total BS.”

“You mean like how it misled me on what my ‘most profitable’ products were?” Roger added.

“Exactly – more of the same. The accounting system just wasn’t designed to answer these questions!”

Rick showed Roger how he had added all the different Profit & Loss lines that had expenses associated with Labor, whether hourly or salary, and entered it into the now unhidden lines on the PCP spreadsheet. “$OE – Other is just $OE – TOTAL minus $OE – Labor.” Rick explained.

Hidden Section

“We separate the two parts of $OE because, although we refer to $OE as being essentially ‘fixed costs,’ the reality is the OTHER part of $OE is more fixed than the LABOR part. You have to pay your rent, utility bills, loan payments, and so on. You DON’T have to hire this office support labor, necessarily. It’s more of a choice.” 

 “That makes sense, I guess, but I don’t like the idea that Labor is expendable – we need the labor, and I don’t want to lay people off,” stated Roger.

“Of course, but we don’t want to get ourselves in the position of having more labor than one can afford, do we?” 

“And yet, so many companies like yours do exactly that. When you have more labor than you can afford, you damage the profitability of the business, and thus damage its ability to grow and respond to changes in the market,” Rick continued, “which is why I am so glad you brought this up. Most of the time, talking about a business’s Labor Cap is about their need to ‘grow into’ their current Labor cost or trim down to the meet the Cap. Both are painful. Having to significantly grow a business without adding ANY people is stressful. But when a business is in trouble, having to cut back to re-establish profitability, that is stress on another whole level!”

“Right, that is why I have been feeling anxious about adding to the office team! This is really interesting! How do we determine my Labor Cap?” asked Roger.

“I'll explain, but before we continue, open up Amazon,” was Rick’s response.

“So, I am buying another book, eh?” Roger asked.

“Of course! Search for Simple Numbers, Straight Talk, Big Profits by Greg Crabtree, and add it to your library. Then read the first four chapters. Greg is one of those CPAs who actually get Throughput Accounting, although he does not refer to it by that name. He does a great job of explaining the concept of Labor Caps that we are walking through now. You can loan it to Bob after you have read those four chapters!”

“Ordered,” announced Roger. “You said I would be reading a lot in this program, and you weren’t kidding! What an education this has been! Please continue.”

“Crabtree explains in one of those early chapters why 10 percent is the minimum Net Profit we want to achieve, so we are just going to go with that. Right now, your business is running about $400K in revenue per month. That means we don’t want the $NP before taxes to drop below $40K.”

“That makes sense,” Roger interjected.

“Good. You have gotten your $T Ratio up to 64 percent,” stated Rick as he examined the PCP Actual section. “Well done! 64 percent of $400K is $T at $256K, which means you have $T at $256K to cover $OE and $NP, since $NP = $T – $OE. Still with me?”

“Yup, although it still blows my mind how you make all this so simple!” was Roger’s response.

“We now can subtract your target $NP, $40K from the projected $T of $T at $256K and get the maximum $OE-TOTAL for a month of $216K. Your $OE – OTHER is running right at $100K per month. This means your Labor Cap is $216K - $100K or $116K. Got that, Roger?” 

“Yes, commissioner Phelps! Under league rules I must keep my team’s labor cost under $116K per month to maintain my minimum Net Profit of $40K,” Roger responded with a big grin.

“We refer to it as the Labor Cap, but the same logic follows for increasing $OE -OTHER when you buy a new machine or Install truck, in which case your Labor Cap will go down. As the business grows, you will be referring to this section of the PCP often, ensuring you stay profitable along the whole journey,” Instructed Coach Rick.

“Certainly makes sense,” Roger responded. 

“I think that’s enough for you to chew on this next week. Why don’t you summarize your goals to achieve before our session next week?”

hiringRoger referred to his notes, then said, “First, I am going to read the first four chapter of my business library’s newest book! Then I am going to see if I can explain it to Bob, my accountant. When successful, I will review with my leadership team. They need to understand how the Labor Cap works and help prioritize what we invest in as the business grows.”

“Excellent! Remember, reach out if you have any questions, by email or text. What was the value of coaching today, Roger, and your biggest takeaway?”

“I will give you another 10! I think my biggest takeaway, apart from the obvious – the Labor Cap – is that I am understanding my business in ways I never dreamed of. No more beating myself up for never going to college!”

With that, the Zoom call ended.

Rick Phelps has been applying the concepts of Synchronous Flow to difficult industrial problems at dozens of businesses and organizations around the world, since the early 1980s.Contact Synchronous Solutions for more information about how our Synchronous Flow Operating System can transform your business, and to learn more about our Executive Business Coaching offerings.

Contact Ed Hill  at (704) 560-1536, or email , or
Rick Phelps  at (216) 533-1387, .

Synchronous Solutions, LLC has developed programs specifically for the stone processing industry.

For more information, visit their website at .

Rick Phelps has been applying the concepts of Synchronous Flow to difficult industrial problems at dozens of businesses and organizations around the world, since the early 1980s.

In 2009, as Cleveland Cliffs’ Director of Continuous Improvement, Rick took on a failing Lean Six Sigma organization, refocused their improvement work using Synchronous Flow, and created a shop floor, engagement driven, continuous improvement process that Cliffs credits with creating a sustained $100M per year reduction in production costs.

Now, back working with Ed Hill at Synchronous Solutions, Rick is once again applying Synchronous Flow in the countertop industry, and having a blast! Nick lives with his family in the Cleveland, OH area.