Hiring Series: Calculating the Cost of Your First Employee

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In a Small Business, everyone has to pull their own weight.  There are two categories of employees: those that produce revenue and those that perform support functions.  You need both, and frequently in a Small Business a single person is both.  Revenue producers are your money makers –  salesmen, professional staff who log billable time, etc, – those whose actual labor brings money into your business.  A revenue producer should pay for herself, that is, she should bring in enough money to cover the costs associated with employing her, and hopefully a little extra as well (your profit.)  Support staff perform functions that are necessary to the business, such a bookkeeping, purchasing and advertising, but do not actually produce income.  The staffing goal of your Small Business should be to maximize your revenue producers with as lean a support staff as possible.  

Kim was definitely a revenue producer.  The big question was: Could we afford to hire someone?  I lost a lot of sleep over this.  I felt a huge responsibility to Kim, who was rearranging her whole life to come work for us.  What if we screwed up?  What if we couldn’t pay her?  What would she do?  Fortunately, Bob, Our Accountant (see my post A Small Business Owner’s Four Best Friends) helped us out by showing us how to run the numbers to see if our Small Business was ready to hire an employee.

First, consider the costs of employing an individual:

1.  Compensation:  Will you be paying your employee a salary or an hourly rate?  An hourly rate gives you more flexibility to control your payroll costs during lean times by cutting employee’s hours, but a salary gives your employee a higher sense of security.  Every job has a pay scale for your geographic area.  If you aren’t sure what that is, ask other Small Business owners, friends, or check the want ads.  There are also several web sites that will give salary ranges for a wide variety of job titles, but I have found these not to be very realistic for my rural geographic area.  (They may be more accurate for larger metropolitan areas.)  Decide upon a realistic pay range, and calculate the low and high cost per year.

2.  Worker’s Compensation Insurance:  When you hire an employee, you are required to purchase Worker’s Compensation insurance.  The purpose of this insurance is to cover expenses, such as medical payments,  incurred if your employee is injured on the job.  Speak to your insurance agent (again, see my post A Small Business Owner’ s Four Best Friends!) to get a quote on the premium.  (The premium is the annual price of the coverage.)   This is usually a fixed base fee plus a variable amount which is dependent upon the total annual payroll and the risk factor assigned to your specific job descriptions.  For instance, a construction company will pay higher Worker’s Compensation premiums than a bookstore, because there is a higher risk of the construction workers being injured on the job.

3.  Unemployment Insurance:  Unemployment insurance is actually a tax payable to both your state and the federal government.  This money is put into a pool to provide income (unemployment checks) to all workers who have lost their jobs.  The annual amount is a assigned by both the state and federal governments, and is a percentage of payroll.  Your accountant can help you determine what percentage of payroll you will owe in both federal and state unemployment insurance.

4. Payroll Taxes:  Federal payroll taxes include Medicare and Social Security taxes.  These taxes are shared by the employee and the employer.  Your share will be approximately 10% of payroll. These taxes go into the general Medicare and Social Security funds to be used for individuals who are collecting those benefits right now.  Your state or municipality may also have payroll taxes.

5.  Additional Benefits:  Are there any other benefits that will be a part of your employment package?  If you will be offering health insurance, will you pay the premium for the employee only or also their family?  If there is a deductible will you cover some of that expense?  Will you offer vacation pay? Sick days?  Determine what benefits you will offer, and calculate the annual cost.

6.  Additional Costs: Try to determine any other costs you will incur as a result of hiring an employee.  Will you need to purchase uniforms for the employee or pay for training or certification classes?  Make a list and add up the costs.

Adding up the costs from items 1-6 above will give you the total annual cost to your Small Business of your new employee.  Surprised?   Notice that several of the items are dependent upon your payroll, so if you offer a lower or higher compensation within your predetermined range, your total costs will go down or up by more than the difference in compensation. 

Second, consider the additional revenue as a result of hiring an employee:

If the employee is a revenue producer, estimate the amount of revenue that individual will produce on an annual basis.  For instance, an attorney billing clients at $80 per hour for 40 hours per week for 52 weeks per year would produce an annual revenue of $166,400.  Of course, no employee will be 100% productive, you may have slow periods, and they will probably take vacation, sick says, and holidays (whether you pay for those or not), so you will need to adjust your revenue expectations from the this ideal example. 

If the employee is not a revenue producer, determine if their employment will allow you to produce more revenue.  Ideally, it should.  Maybe this person will take some of the support tasks off your plate and allow you to focus more on income maximization.  Try to calculate the increased income as a result of this person’s employment.

Last, do the math.  If the cost of employing an individual is higher than the additional revenue brought in as a result of the hire, your Small Business probably can’t afford the employee. 

We did end up hiring Kim, and she was just as great as we had hoped.   Have you hired your first employee yet?  How did you feel before hiring your first employee?  Did you have a better method of determining if your Small Business was ready?