When hiring a new employee, all the potential candidate sees is the salary. But for the employer, there’s more to that figure than meets the eye.
Employees need recruiting, onboarding, and training, among other expenses, and by the time they start producing, they will have cost the employer almost a half year’s salary.
So, if you’re planning to expand your business and need to hire new staff, it’s essential to know how to calculate the cost of each employee.
Apart from the amount you pay to the employee and government, there are other extra costs like overhead, equipment, training, and so on, for each new hire.
The cost will vary depending on the size and type of business, as well as the level of the employee. So, how much does an employee cost?
In this post, you’ll learn how to determine the cost per employee to help you make better hiring decisions.
How to Determine Employee Cost
The actual employee cost is their total compensation, plus benefits package, taxes, and any additional expenses your business accrues from the hiring process.
The cost differs from one industry to another, but in most cases, it accounts for around 60 percent of expenses.
According to a recent report by the Bureau of Labor Statistics, the average private sector employees cost employers $38.61 per hour worked.
The average benefit costs accounted for $11.42.
When it comes to calculating the total cost of an employee, there’s no one-size-fits-all method, because the cost of hiring a software developer differs from accountant hiring cost
And with the rise of remote work, it can be quite complicated to know how much work-from-home pay should be.
Joe Hadzima, a senior lecturer at MIT devised a formula that can provide a safe estimate when trying to budget for a new hire. In his opinion, the average total costs for an employee are between 1.25 to 1.4 times the employee’s base salary. This formula is based on the fact that you’ve taken into consideration basic salary, benefits, and taxes.
For instance, say you are employing a new worker with an annual salary of $35,000. According to Hadzima’s formula, the true cost of that new hire will be between $43,750 and $49,000.
If you’re hiring an hourly employee earning $20 per hour, their total cost will fall into the $25 to $28 per hour range.
Similarly, CNN reporter Jose Pagliery stated that the real annual cost per employee ends up “being 18-26 percent more than a worker’s base salary, and it can be higher for larger companies.”
Using his estimates, an employee with a base salary of $35,000 per year actually costs the employer between $41,000 and $44,100. For an hourly worker earning $20, the real total cost ranges between $23.6 and $25.2 per hour.
This simple formula can be useful for small business owners planning to expand but don’t know how to calculate employee costs. However, you’ll need to know the specifics of the costs you’ll be paying a new employee before bringing them onboard.
Here’s a breakdown of factors that affect employee cost:
Before anything else, you must consider the base compensation, the amount of money you’re going to pay your new employee.
It could be a base salary (a standard for exempt employees) or an hourly wage (applicable to non-exempt workers).
Typically, base pay makes up the largest percentage of an employee’s total cost. But other additional factors contribute to high employee costs, and failing to consider them spells trouble for your company’s bottom line.
Employee Recruitment and Hiring
Recent data by the SHRM on the real cost of recruitment shows that it costs nearly $4700 per hire.
According to Edie Goldberg of E.L. Goldberg and Associates, California-based talent management and development company, most employers estimate the average hiring cost to be three to four times the employee’s salary.
So, if the annual base pay is $35,000, you may spend $105,000 or more to fill that position. But where do these costs come from?
Internal Recruiting Costs:
- Job posting fees. To find the right talent, you need to post the position on job boards like LinkedIn or ZipRecruiter, which require a fee to post and promote your job posting.
- Man-hours. The recruiting manager and HR team will spend hours of admin work creating job posts, doing paperwork, posting the position online, and conducting interviews. That’s time, energy, and resources that contribute to the cost of an employee.
- Recruiting software. You will need applicant tracking software (ATS) to manage the hiring process.
- Background checks. You need to know the credibility of your new hire, and that entails conducting background checks. Statistics by Criminal Watch Dog show that it usually costs $15-$20 for a county court criminal background check and $10-$20 for a statewide criminal background check. Drug and alcohol tests can cost up to $80 per test.
External Recruitment Costs
If you opt for external recruiters, you’ll have to pay them a percentage of the new hire’s base compensation as a retainer fee, which can range from 15-30 percent.
To learn more about “purple squirrels” check out this article: A Purple Squirrel: How to Become the Perfect Job Applicant.
Onboarding and Training
It takes time and money to hire a new team member.
However, your investment won’t start paying off until they are generating revenue.
You will need to train the new hire in the specifics of their role and will usually be managed by you or another employee.
Typically, it can take up to 12 weeks before they operate at 100 percent productivity.
During this period, the new hire isn’t operating at maximum productivity level and is, in fact, costing the employer between 25-75 percent of the employee’s wages.
With effective employee onboarding and training, you can shorten time-to-productivity. Good onboarding can lower the turnover rate and lengthen a team member’s tenure.
Using onboarding software can simplify the onboarding process and help you regulate the onboarding costs.
Regardless of your business type and whether you have in-office or remote teams, you’ll need to empower your employees with certain things so they can perform their roles properly. These include:
- Office space: On-site workers will need an office to work from. Renting office space is one of the largest expenses for many businesses, and will only increase as your team grows and demands a larger office.
- Utilities. An office will need lighting, heating, cooling, and water. The more people you have the higher the bills.
- Office supplies. From pens to papers and laptops, to printers and space heaters, all will play into your overall overhead expense.
- Work from home overhead. Whether your workforce is fully remote or hybrid, you may incur overhead costs, such as a stipend to cover coworking space or pay part of their utilities.
- Basic operating costs, like running payroll, transportation, break food, and lunches must also be factored in.
If you employ non-exempt workers, and they work for a certain number of hours more than their allotted hours per day, they are eligible for overtime. Unplanned overtime can significantly drive up employee costs, especially if you have a large crew.
You want to keep an eye on it not to go overboard. Consider using a time tracking and attendance system to help track overtime costs and effectively manage employee workloads.
Payroll Taxes and Insurance
All businesses are required by law to pay taxes for their employees. The Internal Revenue Service (IRS) outlines the payroll taxes for employers in detail. Here’s a summary of what you’re required to cover by law:
- Federal Insurance Contributions Act (FICA). This is a mandatory payroll deduction that covers social security and Medicare for your employee. These funds offer benefits for retirees, people with disabilities, and children. The current FICA rates are 7.4 percent of taxable wages per worker per year: 1.45 percent for Medicare and 6.2 percent for social security.
- State Unemployment Tax (SUTA) or State Unemployment Insurance (SUI) varies from one state to another, and can dramatically increase employee costs. Generally, the SUTA tax ranges between 2.7-3.4 percent.
- Federal Unemployment Tax Act (FUTA). Employers are required to pay six percent of taxes for the first $7,000 earned by a worker. The funds from FUTA create the Federal Trust Fund. That said, some employers may receive a 5.4 percent FUTA tax credit, meaning they only pay 0.6 percent.
- Local taxes. You may also want to check with the local cities, counties, or jurisdictions to determine if there are any additional taxes imposed on businesses and budget for those taxes.
Worker’s Compensation Insurance
Businesses must pay Worker’s Compensation insurance, which covers employees who are injured on the job. The funds provide the injured:
- Wage replacement benefits
- Medical treatment
- Vocational rehabilitation
Worker’s compensation is regulated by the state, with each job classification being assigned a percentage on each $100 of payroll (salary or hourly wages). Here’s information to give you an idea of how much you can expect to pay in your state.
Employee Benefits and Perks
One effective strategy companies use to attract and retain talent is offering employee benefits and perks. Obviously, these costs add to the overall employee cost. Here are some of them:
Health insurance may be the greatest single expense besides base remuneration. A 2021 report by Kaiser Family Foundation (KFF) shows that small business owners pay an insurance premium of $6,440 for single coverage and $16,253 in premiums for family coverage.
You may opt to provide full premium coverage or a percentage. No matter your choice, it’s not cheap, and any outside help you can get, such as Small Business Health Care Tax Credit can be a lifesaver.
Other employee expenses that will impact employee costs include:
- Retirement plans like 401k matching and pension schemes, which are non-mandatory
- Paid Time Off (PTO). Certain employees are entitled to up to 12 weeks of unpaid, job-protected leave each year, as per FMLA.
- Performance bonuses and promotions
- Dental Insurance
- Life Insurance
- Disability insurance
While some of these benefits are voluntary, they play a huge role in attracting and retaining top talent.
Employee Time Theft
You can’t ignore the financial loss caused by employee time theft, which is estimated to cost businesses up to $50 billion annually.
This crime can be carried out in various forms, including buddy punching and early punch in or late punch out.
A reliable time tracking tool like Traqq can help curb cases of employee time theft by automatically capturing clock in and clock out times.
Variables That Impact Total Employee Costs
With that in mind, certain variables impact employee costs and must be considered before calculating the total cost of an employee. These include:
- Location. Conducting business in some states can be expensive.
- Industry. In some industries, there is a standard employee pay that you must match. Additionally, certain benefits are expected.
- Education and experience. Employee costs will vary by qualification, work experience, and role. For example, senior or high-level roles require higher compensation than junior workers.
- Remote workforce. If your business operates fully remotely, it will cost significantly less compared to having in-office teams.
- Ongoing training and education. Investing in the professional and personal development of your employees not only ensures employee happiness and loyalty but also boosts productivity. However, keep in mind that these expenses will impact employee costs.
- Team camaraderie. Team building activities and virtual retreats are great morale boosters and can improve employee engagement. But these happy moments will cost you.
- Meetings. While meetings are necessary, avoid having too many of them. 71 percent of meetings are unproductive and result in hundreds of hours and money lost.
- Turnover rate. The higher the turnover rate, the higher the employee cost. So, you must strive to develop strategies to keep talent in their roles.
How to Calculate the True Cost of an Employee
Now that you understand all the factors and variables that impact employee cost, you must be wondering how to arrive at the real cost of your employee.
So, to calculate the final cost of an employee, you will need to add together:
- the base compensation (salary/total hours worked)
- total mandatory expenses (FICA, FUTA, SUTA, and Workers comp)
- total non-mandatory expenses (employee benefits)
Here’s an example of the actual employee cost for Sam, who’s earning $35,000, and Joyce earning $60,000 per year.
|Annual Employee Cost||% Of base salary||Sam||Joyce|
|Total mandatory expenses|
|FICA social security||6.20%||$1,860||$3,720|
|FUTA||6% of the first $7,000||$420||$420|
|Worker’s comp||$0.74 for each $100 of base pay||$222||$444|
|Total Employee Cost||$38,057||$74,224|
From this example, on paper, it appears as if you’re paying Sam $30,000 and Joyce $60,000. But in reality, you’re spending $8,057 more on Sam and $14,224 more on Joyce.
Here’s another example of an hourly employee earning $16 per hour. Assuming the employee works 40 hours a week, for 50 weeks, the total worked hours will be 2,000:
40 hours per week x 50 weeks per year = 2000 hours
Next, we’ll need to find the employee labor cost by multiplying the hourly rate by the total hours worked in a year:
$16 x 2,000 = $32, 000
The real employee cost for this employee will be:
|Employee cost of labor||% Of annual labor cost||Total|
|$32,000||FICA tax (7.6%)||$2,432|
|$32,000||FUTA tax (6% of the first $7,000||$420|
|$32,000||SUTA tax (2.7%)||$864|
|$32,000||Worker’s comp ($0.74 for each $100 of wages||$236.8|
|Total Employee Cost||$40,321.8|
The total employee cost for the hourly employee is the sum of the annual labor cost ($32,000) and total annual expenses ($8,312.8), which is $40,321.8.
Therefore, the real employee cost for the worker will be:
$40,321.8 / 2000 hours = 20.16 per hour.
Why Understanding Employee Costs Is Crucial for Your Business
Accurately calculating your employee cost is not only a great hiring practice, it’s a crucial budgeting process.
It gives you an accurate figure of how much each employee costs, allowing you to effectively monitor the costs and profitability of projects.
Additionally, you can budget, analyze, and track projects more effectively.
With such data, you can avoid going over budget and risk going bankrupt.
It also gives you insights into the various strategies you can implement to retain talent.
How to Reduce Employee Cost
You can employ various tactics to cut down employee costs while ensuring you maintain a strong work culture:
- Shift to remote work or hybrid work, which as data shows, can save up to $11,000 for each employee at least 50 percent of the time.
- Hire international teams if possible. Not only will you get to choose from an expansive talent pool, but you can also end up paying lower salaries, especially if you hire from countries with lower costs of living.
- Review and adjust optional benefits packages and eliminate those receiving low engagement.
- Leverage technology to optimize employee efficiency and productivity while cutting down on hours worked. A 2017 report by McKinsey states that in about 60 percent of occupations, at least one-third of the activities required to accomplish a specific job can be automated. Automation saves time and reduces effort, allowing workers to focus on pertinent tasks that promote business growth.
Use Traqq to Keep Employee Costs Down
As your business grows, you can’t afford NOT to add one or more employees to your team.
Knowing how much an employee costs will help you budget accordingly and determine if you can afford an extra team member.
A time tracker like Traqq can ensure that you accurately track employee work hours and monitor performance and productivity levels.
It makes it easier to keep an eye on overtime, and helps you detect employees who are exceeding their stipulated work hours.