Understanding the True Cost of An Employee

As a small business owner, you don’t have much margin when it comes to the cost of doing business. The employees you hire are so critical to the success of your business, but how do you decide how much to pay them?

There are many aspects to this decision, but in order to set an hourly (or salaried) rate for an employee you first need to understand the factors that contribute to the overall cost of that employee. Once you understand the true cost of an employee, you’ll be able to use that figure to determine pricing for the services you offer.

Today’s post is brought to you by Marian Ellis, one of our amazing accountants on staff at Joy Accounting. Enjoy!

Why are labor costs important to your business?

One of the decisions that every business owner must make is how much to charge for services.  While there are many factors that impact your rates, the most misunderstood is generally employee labor costs.

While some might think that labor costs are easy to calculate (you pay your employee $20/hour so it must cost you $20/hour) the reality is that the average employee’s true cost can be anywhere from 25-40% higher than their hourly rate.  If you generate estimates for your customers based off an erroneous labor rate, you run the risk of cutting into your profits or, in a worst-case scenario, losing money on customer jobs and projects.

The value of knowing your true labor rate goes beyond client billing.  It is important for business owners and managers to understand the cost of non-billable work (time not spent working directly on customer projects).

It is virtually impossible and likely counter-productive to attempt to eliminate all non-billable time.  Meetings, other administrative tasks, and training are simply a part of doing business.  Knowing the true cost of these activities, however, will help you eliminate the unnecessary tasks and determine alternate value-added tasks to focus on instead. For example, if your employees are engaging in a manual administrative activity every week that adds up to a total true labor cost of $500, you might consider ways of automating that process to reduce costs.  Perhaps an automated solution might cost $300 per week.  If you do not understand your true labor cost, it would be impossible to do an apples-to-apples comparison and make an informed decision.

How to determine your true employee cost

The true employee cost calculation will be different for every business.  There are, however, several elements that you should consider when doing your calculation. Of course, some of these items (i.e. payroll taxes) are fixed, while others (i.e. paid time off) can be set based on your discretion, and your decisions around these discretionary items will cause the true employee cost to fluctuate considerably. The elements to consider are as follows:

  • Payroll Taxes – Federal/State Unemployment, Social Security, Medicare, Workman’s Comp, local payroll taxes, etc.
  • Health Insurance – Employer paid premiums
  • Retirement Benefits – Plan management cost and employer matching contribution on plans such as pensions or 401(k)
  • Paid Time Off – Paid breaks, vacation time, sick leave, paid personal time, paid holidays
  • Overhead – Expenses such as office space, recruiting costs, supplies/tools, administrative costs (recruiting, payroll), uniforms, company paid cell phones, computer equipment, etc.

Knowing how much your employees cost is a requisite of any well-functioning business. As with many accounting and financial concerns, it is highly recommended that you reach out to a professional, such as Joy Accounting Services, for assistance.  Calculating employee costs and streamlining processes to reduce non-billable time are only two of the many skills that we bring to the table to help grow your business.

About Nate Joy

Nate is the Co-founder and Owner along with his wife Terra. Nate joined the team full-time in Spring 2017 with 10+ years of Project Management/Business Analysis experience. He works with clients on process improvement and software implementation.

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