When Should You Hire? How to Calculate the Cost of an Employee
May 26, 2023
Small business owners are scrappy and often used to wearing “all the hats” in their business. As a result, they run the risk of overwhelm and burnout. It’s tough to know when to hire help, but to create a sustainable and long-lasting business, you can’t realistically do everything. You need to hire help to bring your business vision to life and grow.
Of course, it’s understandable to worry about the financial side of hiring new employees. To help determine whether you can afford to hire, we’ll show you how to calculate the cost of an employee.
How to calculate cost of an employee
When you bring on a new hire, your total cost includes more than just their salary. In fact, according to the SBA, the cost of hiring an employee is typically 1.25 to 1.4 times the salary for the position, although it varies depending on a few different factors.
One of the most significant costs are payroll taxes. These include the employer’s share of:
- Federal Insurance Contributions Act (FICA) taxes, which include Social Security taxes and Medicare tax. This is 7.65% of the employee’s gross salary,
- Federal Unemployment Tax Act (FUTA) taxes, which are 6% of the first $7,000 of wages paid to an employee each year, and
- State unemployment tax (SUTA), sometimes referred to as unemployment insurance. The state unemployment tax rate varies by state.
Other labor costs
Beyond state and federal taxes, there are several other hiring costs to factor into your budget, such as:
- Payroll processing fees, such as the cost of payroll software or outsourcing payroll to a third-party
- Employee benefits, including health insurance and dental insurance and vision insurance. Providing employee benefits is a significant expense for employers. However, many employees expect these benefits, so it might be necessary to offer competitive benefits to attract and retain talent.
- Workers compensation insurance, which varies in cost depending on your state and industry
- The employer contribution to an employee’s retirement savings
- Recruitment costs, such as recruiting software, working with a headhunter or staffing agency, and running background checks
- Onboarding costs, including initial training, uniforms, and any other required tools or gear
- Other overhead costs, such as office space, a desk and computer, software licenses, and office supplies
How to reduce employee costs
The list of total employee costs might seem daunting, but remember that most of these costs are fully tax-deductible, so they can reduce your federal and state tax liability.
Also, there are several federal tax credits that can help reduce employee costs, such as:
- Work Opportunity Tax Credit
- Small Business Health Care Tax Credit
- Retirement Plans Startup Costs Tax Credit
Calculating your total employee cost
When thinking about hiring, it’s important to think of both the employee cost and benefits. Ideally, hiring a new employee should either increase your revenues or decrease your expenses. So before you take on added labor costs, it’s helpful to calculate your break-even point.
The break-even point is the point at which revenues and expenses are equal. In other words, you “broke even” because there were no net profits or losses. You may have performed a break-even analysis when you started your business to determine whether your business model was profitable, how many products or services you need to sell to cover your fixed costs, or whether to invest in new equipment. But you can also use it to decide whether you can afford to hire.
Calculating your break-even point: an example
For example, let’s say you own an event planning business, and you’re so busy that you’ve had to turn down jobs. You want to hire an employee to help take on some of that workload, and you plan to pay them $50,000 per year.
If we use the 1.25 times annual salary method for calculating total employee cost, the new hire will cost you $62,500.
Now, let’s say you average $10,000 in profit per event. How many additional events would you have to take on to break even?
$62,500 divided by $10,000 is 6.25. So to break even on the cost of an employee, you would have to book an additional 6.25 events per year. Any additional events over that break-even point would be pure profit.
If you’re currently turning down two events per month because you don’t have the capacity to take them on, then you know you can afford to hire.
Just keep in mind that it takes an average of 6.2 months for an employee to start adding more value than they’re consuming while they’re being trained and learning the job.
However, the break-even point is just a starting point. It’s also essential to consider the potential long-term benefits of hiring the employee, such as the ability to scale. If the new employee can help grow the business, the investment may be well worth it.
Alternatives to hiring a new employee
If you calculate your break-even point and realize the numbers don’t add up, you’re not out of luck. You may decide to hire a part-time employee or an independent contractor instead.
Hiring an independent contractor might make more sense when you only need someone for a short-term project, like designing a logo, building a website, or setting up a marketing funnel. It might also make sense when you need someone to perform a specific task that isn’t part of your core business operations, like handling your social media.
Ultimately, the decision of whether to hire an employee or an independent contractor will depend on the specific needs of your business. Either way, it’s important to carefully consider your total employee cost before making the decision to hire. By understanding the true cost of hiring employees and weighing the pros and cons, you can make an informed decision that is best for your business.
If you’re spending a lot of time on bookkeeping, please reach out! We’d be happy to take that task off your hands and allow you to focus on growing your business. We can also help you run the numbers to calculate employee cost, figure out an employee’s base salary, and decide whether now is the right time to hire.