How To Determine The True Cost Of An Employee

When growing a company's team, many HR managers and business owners think their only expense is the employee's wage. However, staff members cost more than the wage or basic salary an employer pays. The company incurs other expenses such as payroll taxes, recruiting costs, employee benefits, training, costs, and non-mandatory payments.

Understanding employee cost and knowing how to calculate it can help you budget and make informed financial decisions.  

Read on to learn everything about the actual cost of an employee, including the formulas to calculate it and the factors and variables that affect the total cost to help your company run a sustainable and profitable business operation.

What Is Employee Cost?

Employee cost refers to the total expenses incurred by a business to hire and maintain staff members. Employee costs include salary, taxes, benefits, insurance, equipment, training and other indirect costs.

One of the essential labour costs businesses may want to calculate are employee costs as a percentage of turnover. These costs help you determine whether you've hired the correct number of employees. It also ensures the number of staff you've hired doesn't consume too much of your profit. 

Benefits Of Measuring Employee Costs As A Percentage Of Turnover

Whether you're planning to hire new talent or are a small business owner hiring its first staff member, calculating employee costs as a percentage of turnover is essential. You can use it to manage the business budget, plan your human resources, and make informed decisions. For instance, if employee cost is too high and the profits are low, you may need to increase labour productivity and reduce labour costs.

Alternatively, if the employee cost against turnover is too low, your company may have a shortage of experienced employees, or its existing staff may be underpaid. Either way, you must make sound financial decisions to ensure profits and that the costs of hiring and maintaining employees are within the acceptable range.

Measuring employee costs as a percentage of turnover also helps companies determine the true value of their employees and the return on investment (ROI) they generate for the organization.

Formula To Calculate The Cost Of An Employee

There are many formulas companies can use when calculating employee cost to determine the true cost of employees. However, the most popular and go-to formula is multiplying their base salary by 1.25 or 1.4. This will determine the minimum (1.25) and maximum (1.4) cost of each staff member, giving you the total employee cost. 

For example, if you hire a new employee whose base salary is £25,000, their total cost is between £31,250 and £35,000. A staff member with an hourly rate of £35 costs £43,75 and £49.

Variables Affecting The Cost Of An Employee

Calculating employee costs can be complicated as many variables, including location and industry, affect the true cost of an employee. Employers need to consider all these variables when calculating employee costs to get an accurate estimate. 

Some of the variables that affect the true cost of an employee include:

1. Location

The cost of compensating an employee varies drastically between states and cities. Each city has its own cost of living, market demands and tax rates. Cities with the most expensive tax rates include Finland (56.95%), Denmark(55.90%) and Austria (55%). Those with the cheapest tax rates are Hungaria (15%), Romania(10%) and Bulgaria (10%). 

2. Industry

Employment norms, salary, pay and benefits vary by industry, and you have to match what your competitors offer to reduce turnover rates. For instance, some industries require employers to cover health insurance while others only offer partial coverage or none. In these cases, the employee cost will vary drastically.

Similarly, industries such as advertising and aerospace have high corporate taxes, which increases your employee cost significantly. Additionally, paying employees hourly or on a contractual agreement instead of a base salary reduces hiring costs.

3. Remote Teams/ In-house Teams

The expenses used to manage remote and in-house teams vary significantly. For an in-house team, you need to factor in costs such as utilities, supplies and rent, which increase your labour costs.

For remote teams, these costs can be avoided, lowering your expenses. However, remote employees also come with added costs like software supply and flying them out to events.

4. Company Size

Small businesses tend to have higher staff member costs when compared to large businesses. Since small companies can't offer employees competitive salary rates, their turnover rates tend to be high. This increases hiring costs as they constantly train and onboard new staff.

5. Turnover Rate

As mentioned earlier, companies with a high turnover rate experience higher staff member costs. The process of hiring and onboarding new employees incurs numerous costs.

For example, the recruitment process alone incurs recruiting costs such as background checks, fees for job postings and recruitment software. 

6. Education and Role

Candidates with higher levels of education, rare skillset and unique experience may demand higher salaries to match their abilities. Companies may also offer them a higher salary to retain them, ramping up the costs of the employees. 

The costs of an employee also vary by role. Senior positions such as CEO and President include other costs like higher benefits and salaries than junior roles.

7. Market Conditions

The supply and demand for employees can affect the cost of hiring and maintaining staff members. For example, if a position requires candidates with rare skill sets, the supply will likely be low, forcing the business to offer higher compensation to find suitable candidates. This, in turn, increases their labour costs.

On the other hand, if there's a surplus amount of candidates applying for a role, the company may offer lower compensation due to the high talent supply. This reduces their labour costs. 

How To Calculate The Cost Of An Employee

There are many other factors also to consider when calculating the true cost of an employee. These include:

1. Recruitment and onboarding costs

When hiring new employees, the first cost companies incur is recruitment. This may include:

• Ad placement
• Recruitment agency fee
• Background checking costs
• Relocation costs
• Recruitment software costs

After the recruitment process, the business has to cover onboarding, training and mentoring fees. If your company is always hiring, knowing the recruitment total costs can help you budget accordingly. 

2. Employee's Salary

Employee annual salary or wage is the largest expense when calculating the cost of a staff member. Businesses have to offer a basic salary that matches industry and government standards to remain compliant and retain employees.

While an employee's base salary is fixed, it's only the minimum and can fluctuate depending on the total hours an employee works. So, if a staff member works extra hours, you have to compensate them their base annual salary plus the extra hours put in.

In this case, it's vital to use time-tracking software to track and manage the number of hours employees work. Time-tracking tools are vital in employee management.

3. Mandatory Payments

Mandatory payments refer to the privileges and benefits employers must offer their employees. These employee benefits vary from state to state and may include pension plans, health care, paid holidays or sick leaves. In the Netherlands, some of the mandatory payments employers are required to cover include the following:

• State pension
• Child care costs
• Health insurance
• Transport allowances
• Workers compensation insurance

You may even have to pay National insurance.

4. Non-mandatory payments (Employee Benefits)

Some employers may voluntarily pay their employee's certain benefits to reduce turnover and improve productivity. These are offered on top of the mandatory costs, contributing to an employee's cost. They may include:

• Dental insurance: 
  This is a common benefit for employees in private and large companies. Some employers fully cover the cost, while others only partially cover it.
• Paid time off:
  Not all employers provide paid time off, but those that do offer packages such as sick leave, maternity leave and federal holidays. Some employers even offer paternity leave. If your business offers this, ensure it has software that tracks the paid leave for its employees. Absence registration software is a good choice as employees can submit leave requests, and the company can approve and track them.
• Savings plan
  Many employers set up savings plans for their staff members. The employees can decide whether to let their employers contribute a part of their wages to the plan. The employer then matches up the percentage of this contribution to the workplace pension plan.

5. Overhead Costs

Overhead costs refer to the expenses that keep the business up and running. They're usually not directly related to labour costs but should be considered when calculating the employee cost.

The standard overhead cost for most businesses includes rent, utilities such as electricity and water, office supplies and operating costs. 

If you manage a remote team, you won't have to incur costs such as renting an office space and purchasing office supplies like desks, computers and chairs. However, you still have to cover other costs, such as offsite expenses like internet allowance for working from home.

Conclusion

Understanding the true cost of hiring and maintaining employees helps businesses determine the total employee cost, which they can use to budget, predict profitability, estimate project costs and make sound financial decisions for growth and sustainability. 

An easy and automated way to help calculate the actual cost of employees is to use management software for employee scheduling, time registration and HRM. Contact Shiftbase today to learn how we can help your business with time tracking and absence management.