Running a small business is about more than your vision and mission statements. Understanding the actual cost of your workforce is key to reaching goals and growing your business over the long haul. Without hard-working employees, your business would not get where it is going, so accurately calculate the cost of employing them to ensure long-term job stability and continued business growth. This involves more than just knowing your employees' salaries. Get an accurate read on the overall labor burden rate your business is paying to support each of your vital team members.
The labor burden rate includes all of the costs associated with your employee, not just the cost of actual pay. Many small business owners underestimate how much it costs to maintain an employee on payroll and end up with bigger losses than expected. Before you consider hiring your first employees or new employees, calculate the fully loaded labor rate, including costs like benefits, employer-paid taxes, paid time off and overhead.
For instance, the starting salary for an associate in your shop might be $30,000 per year, but it would be a mistake to conclude that this is the cost of employing him. After benefits, taxes, paid time off and overhead, you might have another $20,000 of expenses associated with that employee each year. The extra costs might look something like this:
- Health costs: $9,800
- Paid time off: $2,500
- Professional development: $2,400
- Payroll taxes: $2,300
- Overhead: $3,000
When those expenses are added together, the total of $20,000 is considered the labor burden rate. To calculate the exact percentage of this burden, divide your additional expenses by the employee's annual salary. $20,000/$30,000 = .67 or a 67 percent burden rate for this employee.
An employee's cost per hour is more than her salary per hour. As shown above, an employee who costs a company $20,000 per year on top of a $30,000 salary actually costs $50,000 per year and has a burden rate of 67 percent. If you calculate this employee's hourly rate by dividing her $30,000 annual salary by 2,080 hours of possible work per year, it looks like the cost to employ this person is only $14.42 per hour. However, when you take into account the burden rate and divide the full $50,000 by 2,080 hours, the actual hourly expense for this employee is $24.04. When you are a small business trying to stay afloat and increase profit margins, a $10 per hour difference is a huge deal. By calculating the fully loaded labor cost per hour of every employee, you can avoid hiring more employees than your business can afford so that you can remain a reliable employer for the people you already have on staff.
While understanding the cost of benefits and taxes per employee could be pretty straightforward, calculating the overhead cost per employee can be a little bit more complicated. The overhead costs per employee include things like building costs, maintenance, property taxes, utilities, office equipment, office supplies and insurance. Once you calculate the overall total for your company, you divide it by the number of employees on staff. See this example for a company employing 43 people:
- Building costs: $24,000
- Maintenance: $10,000
- Property taxes: $3,500
- Utilities: $8,500
- Office equipment: $7,000
- Office supplies: $4,500
- Insurance: $100,000
- Total: $157,500
- Total per employee: $3,663
Keep in mind that this number will vary by industry and company. Some industries will require safety gear for all employees, uniforms, special laboratories, operating rooms, manufacturing centers and more. Other businesses may completely eliminate categories like building costs, property taxes and maintenance, especially cyber companies that do not require central offices. The employee overhead total includes any costs that do not vary from employee to employee and are required to employ your workforce.
Many small businesses do their own accounting when they are just starting out. Accuracy is important in every aspect of accounting and especially when calculating the costs of maintaining your workforce. If you miscalculate these numbers, you could end up having to lay off employees, or you could miss out on needed revenue to grow your business. Arriving at an accurate labor burden cost depends on having accurate records about how much you are paying each employee, the number of hours they work per period, tax expenses, insurance and overhead. Assuming your business keeps accurate records for each of these categories, several free online calculators are available.
Even though online calculators are available to help you figure out the labor burden rate for your employees, they might not be entirely accurate. Your specific business might have unique expenses that qualify as part of overhead, insurance or taxes. If you leave those numbers out of the equation, you could walk away with an inaccurate picture of what it actually costs to employ your crew. Consider consulting an accountant who can look at your books, catch your blind spots and help you make sure that every pertinent expense is included in your calculations. As a small business grows, having a relationship with an experienced accountant is beneficial not only for calculating labor burden costs, but also for taxes, projecting profits and keeping cash flow in check.
While it might seem as if you have no choice but to pay a high labor burden rate for your employees, there are ways to cut costs when your bottom line depends on it. Reducing the labor burden rate could enable you to maintain a larger workforce or keep from laying off treasured members of your team. Cutting overhead costs is one way to reduce the labor burden rate. If you have members of your team who work from a computer, could they work just as productively from home as from the office? Consider offering employees the option to work remotely and then scale down your office size. Not only does this cut costs for you, but it also cuts costs for them in terms of transportation, eating out and professional wardrobe.
Other ways to reduce the labor burden rate are to evaluate pay increases, reduce turnover rates, convert full-time employees to a four-day work week or employ some people as independent contractors rather than salaried employees. When it comes to independent contractors, your business could likely afford to pay a higher per-piece rate to an independent contractor and still maintain a lower labor burden because they are responsible for paying their own taxes and benefits. This means that you are not paying for their health insurance, Social Security taxes and days off. For those you maintain as salaried employees on the payroll, consider limiting expenses for things like travel, meals out or company vehicles.
Sometimes, a higher labor burden cost is worth the price tag. For instance, you might have a powerhouse expert on payroll who is in demand within your field. She has inside knowledge that you cannot get anywhere else, and if your competitor were to employ her instead of you, your company would lose its edge. In this case, maintaining a generous salary and benefits package is worth the expense because it increases your overall bottom line. While it is worth paying more for excellence, strive to have your strongest employees teach and train the other members of your workforce so that everyone's level of performance is raised. This increases the performance of your team and your profit margins and makes you less beholden to bearing a disproportionately high labor burden cost to keep people on payroll.