When you run a business, budgeting becomes an important part of your life. Although there’s software that can help, it’s still important that you understand the various concepts related to setting and following an operating budget. Of the many expenses you’ll incur, employee salaries will be among the most expensive, but they’re also crucial to moving your business forward. When you’re planning ahead for a new hire, you’ll think of that person’s pay in terms of an annualized salary. However, the job candidate will see it in terms of annual salary, which is the pay he can expect to earn during a given year in your employ. These are two very different concepts.
An annual salary is the amount a person can expect to make in a year. Annualizing a salary means calculating the amount an employee would make, even if he doesn't work 12 months of the year, and arriving at a number for the year, usually for budgeting purposes.
The term “annualized salary” often comes up when you’re budgeting for an employee who won’t be with you a full year. If you hire a worker in August for $70,000 a year, that employee will not be making $70,000 that first year. If that worker retires or resigns partway through a latter year, you also won’t be paying the full amount. To calculate salary in this case, you’ll annualize it, which simply means figuring out how much that employee will make during the designated portion of that year and then multiplying that by 12.
You may also find yourself annualizing a salary for hourly or part-time workers. You’ll need to know the number of hours the employee works in a given year and then multiply that by hourly pay. If your employee works only 10 hours a week at $12 per hour, for instance, that employee would work 520 hours per year assuming there is no unpaid vacation time or sick leave taken. Multiply 520 by $12 and you’ll get an annualized salary of $6,240.
When you’re conducting job interviews, you don’t quote the employee the amount she’ll make for the remainder of the year. Instead, you quote a base yearly income, which is simply the salary the position pays. You may mention benefits like retirement contributions or vacation days, but you don’t calculate this amount and add it on to the base salary for the position. The employee can then divide that amount by the number of paychecks to determine how much gross pay she’ll make before taxes and other deductions are taken out.
For budgeting purposes, you will likely want to use the annualized figure rather than how much you promise to pay the employee when you hire her. The annualized figure will show how much you actually paid the employee in wages based on the time she actually spent in the job. If she started in November or left in February, this will be a much smaller part of your yearly budget than if she worked the entire year.
Salary isn’t the only employee pay factor to consider when drawing up a business budget. If you have a full staff, you’ll probably be able to look at last year’s numbers and adjust for any changes you plan for the coming year. You can’t always predict when someone will leave, but if you know the planned date of someone’s retirement and you plan to eliminate that position, you can strike that amount from your budget in advance.
Once you define base salary for each position, you’ll also need to add on expenses like bonuses, overtime pay and payroll taxes. These costs may fluctuate from one year to the next, especially as your business grows and you increase the number of employees you have on board. However, you’ll also find that budgeting your payroll each year makes it easy to find areas where you can cut back when funds get tight.