What is the Cost of an Employee?
As a small business owner, I care about the cost of an employee. When we create a budget there are a lot of things to consider.
Follow along as I calculate the cost of an employee…
How Much Does an Employee Cost?
The average employee cost is 1.25 times base salary. That’s roughly 25% over base salary (or payroll cost per employee). This is a good rule of thumb for a ballpark estimate.
If you have an annual budget of $70,000 for a new employee, that means you can either:
- hire an employee at $56,000 annual salary, or
- expect to pay about $87,000 in total
Employee Costs Are More Than You Think
As you can see, a simple budget of $70,000 isn’t a realistic view of the true cost of an employee. It’s either a lot more or a little less than what you are budgeting. Probably a lot more.
There are other things that can increase the cost of an employee. Depending on your level of engagement with your employee, your employee costs can soar.
Following are 9 considerations that affect the cost of an employee in your business.
I’ve also included a brief tip to help you address each of these potential problems.
My bottom line: use good hiring and timekeeping software. It will save you a lot of money.
Here are my 10 considerations:
1. Employee Recruitment
The first cost you will incur when hiring an employee is the recruitment cost. This is also called cost-per-hire. I include this one-time cost in my total employee cost calculation as a function of budget.
This cost is usually separated by department, but it should be part of your total employee cost. Collecting and maintaining data across many departments can be difficult. The best way to manage this cost is to use historical data to reach an assumption. Applicant tracking software analytics makes it easier.
Work with your assumption and compare to the most recent data at regular intervals. Revisit this often to arrive at a reasonable true cost of an employee at your business.
Recruitment costs include:
- Labor expenses for in-house hiring team
- Costs for outside hiring agencies
- Costs for online recruiting services
- Costs for career events
- Costs for background check/drug testing services
- Costs for internal referral bonuses
The hard part to calculate is the human time it takes to create accounts, job descriptions, and manage placement.
If you are hiring more than 1-2 employees a month, it makes sense to identify cost-per-hire. Knowing this number will help you budget for long-term growth.
Expert Tip #1
Hiring software reduces the cost of an employee before and after the hire date. It automates many of the hiring tasks. It also shortens time-to-hire which reduces several indirect hiring costs. Recruitment software improves the quality of hire. Quality employees are more productive. Employee performance and profitability go hand in hand.
Learn how to hire quality employees in our series How To Hire Your Perfect Next Employee: The Ultimate Guide. This comprehensive series teaches you best practices for hiring in 2019.
- Improve quality-of-hire
- Shorten time-to-hire
- Reduce recruitment costs
- Improve hiring team efficiency
- Measure recruitment metrics
- Improve the candidate experience
- Strengthen your employer brand
Save money by providing incentives to employees for referrals. Referrals are the cheapest way to reducing hiring employee costs.
Referral bonuses encourage existing employees to keep their eyes peeled. Referral candidates have one level of vetting before they meet with management.
Another way to save is to hire from within the organization. Of course, this will leave a gap somewhere down the line.
Hiring from within your organization allows you to leverage experience. It also lowers costs to entry-level employees where recruitment costs are lower.
Focus on hiring entry-level employees and moving more experienced ones up the ladder. Recruitment costs per employee are lower for entry-level positions.
2. Onboarding and Training
You spent a lot to hire your new employee. But the investment won’t start paying off until they are generating revenue. You have a major incentive to shorten time-to-productivity.
Expert Tip #2
Onboarding software simplifies onboarding programs. Structured, lengthy onboarding starts the new hire on a path to success. Compare your turnover rate to similar companies. If your rate is higher than average, revisit your onboarding and training programs.
3. Payroll Wages and Overtime
Payroll wages are the easiest part to calculate employee cost. Overtime can throw your budget out of whack in no time.
The payroll cost per employee is straight up: what are you paying the employee? This is an easy cost to predict and is the most stable part of your employee cost.
Overtime is another story. If your employee is on a salary basis, this is going to be negligible or nonexistent. If your employee is hourly, this can fluctuate quite a bit. You’ll want to keep an eye on it.
Unplanned overtime is one of the great downfalls of business. If you have a large crew on a factory floor, your overtime costs can soar to critical levels.
Expert Tip #3
Overtime alerts warn you when shift swapping or gap filling are breaking the bank. Warnings prevent accidental approval of overtime.
Biometric clocks can also reduce buddy punching and other kinds of hours theft. Every business is subject to time theft, but biometric clocks can reduce the impact.
Restricting punch in and punch out times can also reduce employee costs. Employees clocking in five minutes early and late each day can absorb thousands. Prevent unplanned overtime and excessive shift time with lockouts and intelligent clocks.
Look at time and attendance scheduling software to reduce unplanned overtime expenses.
4. Employee Benefits and Perks
In this section, we are considering all benefits except health insurance. Employee benefits vary from company to company. They also vary from employee to employee.
Complexity, variation, and employee matching options make benefits unique to each employee.
Benefits include 401k matching and even local entertainment benefits. For example, your company may offer employees a subsidy discount to a local zoo, pool, or park.
Participation is another factor that can influence the cost per employee. You will find that some, but not all employees take part in entertainment or social benefits. This makes it hard to calculate the cost of an employee.
Benefits are an important part of your recruitment and retention strategy. Scrimp on benefits at your own peril, but work to find a good balance between enough and too much.
Expert Tip #4
Work with a good provider to offer a limited group of options for employees. The more you can standardize, the more you can depend on consistent expenses.
Use employee self-service solutions to empower employees to manage their own benefits. Saving money on maintenance of your employee benefits is a good way to lower costs.
Employee self-service also allows employees to manage their own profiles. They can also take on scheduling functions and other HR related tasks. Employee self-service can reduce the impact on HR and save a lot of interruption time. Time is money. A self-service HR portal is effective employee expense software.
Historic data in your time and attendance software can help you forecast. Measure employee participation to make more accurate estimates of benefits adoption and usage.
5. Employee Payroll Taxes/Workman’s Comp
Social Security/FICA, Unemployment and Medicare are the taxes to include.
Social Security and FICA can account for 6.2% of the first $90,000 you pay your employee. These costs are pretty set and can be forecast with accuracy.
Unemployment (FUTA) will run you about 6.2% on the first $7,000 of salary. Besides federal unemployment tax, there may be state unemployment tax for your area. Requirements vary from state to state, so make sure you are in compliance.
Medicare will cost about 1.45%. There isn’t a limit on this tax, so remember to consider this ongoing.
Don’t forget Workman’s Compensation, which is a variable cost that can run between .3% to 7.5%. The difference will be in the type of employee.
Job roles become important when calculating employee payroll taxes. Keeping a good history in your employee expense software will help protect you from audit trouble.
Archive records will also help in the event an employee files a claim against you.
Expert Tip #5
Time and attendance software with job role tracking is a big help. Job role tracking will help you forecast insurance costs. It can even help reduce insurance costs as you plan for new job roles.
Historic data will help you forecast as well. Use last year’s expense report to refine your employee costs for future planning.
6. Health Insurance
Medical insurance will be your greatest single expense outside of salary and wages. Research shows that 84% of companies with up to 200 employees offer health insurance.
According to SHRM, the average insurance costs per employee increased from $14,099 in 2018 to $14,800 in 2019.
Some companies provide full premium coverage while others offer a limit or percentage. This is an obvious area of customization for your company.
Your company health insurance strategy will be unique. Consider all types and apply a percentage to your calculated employee cost.
Insurance is an area where outside help can be a lifesaver. Complicated options and new federal regulations mean this area requires specialization. You’ll do a lot better to seek advice from a professional.
Expert Tip #6
Empower your employees to take some of the administrative burdens from your managers. Employee self-service can reduce administrative expenses and yield ongoing savings.
7. Retirement Benefits
Small businesses rarely offer retirement benefits. If your company does, they are something to consider for the true cost of an employee.
Retirement benefits such as pension plans or ongoing service benefits are long-term costs. These costs are part of the true cost of an employee and are difficult to predict.
Aging, attrition, and changing financial structures can impact retirement forecasting. This makes it difficult to calculate retirement benefits as an employee cost.
Regardless, retirement benefits are part of your true cost of an employee. Historic data in your employee expense software will be helpful in planning.
Expert Tip #7
Like many other items on our list, retirement benefits warrant professional help. This is a complex area subject to regulation, contracting, and union considerations. You will need help.
Time and attendance tracking with historic archiving is essential. Retirement benefits are often related to work history. Make sure you have a well-documented history with a solid time and attendance app.
8. Performance Bonuses
Performance bonuses are often tied to salary and sales or production objectives. The problem for forecasting these calculations is the variable of the outcome.
When deciding how to pay employees in a small business, remember that performance bonuses usually provide a reliable ROI. Performance bonuses are often tied to an income-producing activity.
Performance bonuses rarely create financial problems because they increase income. Or at least they should.
The problem is that this cost is variable, and can increase the true cost of an employee. This makes forecasting employee costs difficult.
Make sure your performance bonuses correlate to income producing activities. This is easy for departments where the more an employee produces, the more income you generate.
It gets tricky in production-related departments such as a factory floor. Employees making widgets don’t impact sales unless production falls behind demand. I’ll leave the nuance to you more capable managers.
Performance bonuses are part of the employee cost calculation. How you arrive at a number depends on your business.
Expert Tip #8
Performance bonuses should include time and attendance objectives. Use employee time tracking software with productivity tools. Review historical data to ensure your employees are meeting goals. Reward according to achievement.
Using time tracking software to measure employee performance can help lower employee costs. Time and attendance data can help you correlate productive time to income.
Analyze data to make improvements to your performance objectives. Optimizing performance objectives will help lower the payroll cost per employee.
9. Indirect Employee Expenses
There is a whole host of expenses that can add to the true cost of an employee. These indirect employee expenses are difficult to quantify. They are a portion of your operating expenses.
For instance, office supplies and technology. Each of your employees uses paper, pencils, tools, tables, desks, and chairs. Plus computers, software, phones, and headsets.
Some employers provide break food, lunches, or per-diem meal budgets. If you have field service workers, figure in transportation costs.
An ecologic footprint is getting down to the micro level of employee cost, but it is a consideration. The cost of electricity includes computer time, air conditioning, and lighting.
Expert Tip #9
Savings on overhead reduces the overall cost of an employee. Can you optimize shifts with better scheduling software? Can you renegotiate office space or equipment leases? Can you sublet extra warehouse space? Give managers incentives to reduce operating costs in their departments.
10. Employee Theft
Finally, we must consider employee theft. I’ve mentioned it a time or two in this article, but it warrants repetition.
The American Payroll Association estimates that theft is affecting 75% of small business. Their focus is on buddy punching and time theft such as early punch in and late punch out.
That likely means my business and your business. We are all at risk and this is a factor in employee cost.
Expert Tip #10
The best way to confront employee time theft is a combination; time and attendance software paired with a verification time clock.
Final Cost of an Employee Calculation
- Multiply the individual employee amount by the number of employees
- Total the company-wide costs (costs not apportioned to a single employee)
- Add these two amounts
- Divide by the total number of employees on your payroll
WorkforceHUB Lowers Employee Costs
Trying to decide how to pay employees in a small business? Make efficient HR management a priority. WorkforceHUB is a comprehensive Human Resources solution.
WorkforceHUB includes time and attendance tracking with all the trimmings. Clock restrictions, job roles, project tracking, compliance—that’s just a few of the tools Plus document management, e-signature, and payroll integration. Add ApplicantStack, our new hiring solution.
WorkforceHUB significantly lowers the cost of an employee.
You paid a lot to get your last employee on board. Use WorkforceHUB to reduce the cost of the next one. You will save far more than the cost of the system.
By Cary Snowden, last updated August 10, 2019
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