When you’re thinking about hiring a new employee—and how much that employee is going to cost your business—the first thing you probably think of? How much you’re going to pay them.
But employee cost is about so much more than salary or wages. And if that’s the only cost you’re taking into consideration when building your team, you (and your budget!) are going to be in for some expensive surprises down the road.
So much does an employee actually cost? What are the different factors that play into employee cost? And how can you figure out just how much bringing a new employee onboard is going to cost—before you make the jump and start hiring new people for your team?
Calculating employee cost
The total cost of an employee is their total compensation plus any additional expenses the business accrues as a result of hiring and employing that person. While there’s no one-size-fits-all solution to calculating total employee cost, the formula most commonly used (and a safe estimate if you’re trying to budget for a new employee) is that the average total cost for an employee is between 1.25 and 1.4 times the employee’s base salary.
So, for example, let’s say you were hiring a new employee with a base salary of $50,000; according to this formula, the true cost of that employee would be anywhere between $62,500 and $70,000. If you were hiring a new employee at $25 per hour, their total cost would likely be in the $31.25 to $35 per hour range.
This formula gives small businesses a good jumping off point to calculate employee cost. But what actually factors into that number—and how do things like your location and industry impact the cost of an employee?
The variables that may impact employee cost
Before we jump into the different factors that play into employee cost, let’s first talk cover some variables that may impact those numbers.
here are a number of variables that could push that total number higher or lower for your business, including:
- Location. Where you do business can play a large part in how much you’ll pay for your employees. Location-based variables like state and local taxes, cost of living, and market supply and demand can all impact your total employee cost.
- Industry. Your industry—and the employment norms within that industry—can also impact your employee cost; for example, in certain industries, offering corporate paid health insurance (which will drive up your cost per employee) is expected—while in others, offering partial or employee-paid coverage is standard.
- Market conditions. Employment markets are constantly shifting; if you’re in an employer market, employee costs might be lower for top talent. But in a candidate market—where top talent have a variety of opportunities and offers—you’ll need to offer more competitive compensation packages, which can drive employee costs higher.
- Role. Employee costs will also vary by role; for example, senior or high-level roles will require a higher compensation package than more junior hires.
- Company size. Sometimes, per person employee costs per person can be lower for larger companies vs. a small business (for example, it might be more expensive per employee to run payroll for 10 people vs. 10,000 people).
- Turnover rate. Employee costs are higher when you have a high turnover rate—so if you have trouble keeping talent in their roles (and you’re constantly having to hire and train new people), you can expect to pay more employee costs overall.
Clearly, there are a number of variables that can impact total employee cost. But no matter what these variables—like location or industry—might be, the factors that make up the true cost of a team member are fairly universal across the board.
So what, exactly, are the main factors that play into the cost of an employee?
Factors that play into employee cost: Base compensation
As mentioned, when you hear “employee cost,” the first thing that probably comes to mind? Base compensation.
Base compensation is how much you’re going to be paying an employee, whether that’s a base salary (which is standard for exempt employees) or an hourly wage (which is typical for non-exempt employees). When you look at employee cost as a whole, base compensation is likely to make up the largest percentage of an employee’s total cost to your company.
Base compensation might be the largest part of employee cost, but it’s by no means the only part—and where business owners get in trouble (and go over budget) is when they don’t look at the additional factors that can drive up employee cost.
Factors that play into employee cost: Hiring
When you bring on a new employee, it (of course) costs money to pay them—but it also costs money to hire them.
The cost of a new hire can significantly drive up total employee cost—and how much depends on your hiring practices.
Internal recruiting costs
If you manage your recruiting internally, there are a variety of costs your business may incur when hiring a new employee, including:
- Recruiting software. If you want your recruiters to succeed, they need the right tools to manage the hiring process—and that means investing in a recruiting or applicant tracking software (ATS).
- Time. Your recruiter and/or HR team will be spending their time, energy, and resources filling each of your roles—and that’s time, energy, and resources you need to factor into the new employee cost.
- Fees for job postings. You need to post your job on job boards (like LinkedIn and ZipRecruiter) in order to attract candidates—and those job boards typically have fees associated with their job postings.
- Background checks.
External recruiting costs
If you decide to hire an external recruiter, you’ll typically pay them a percentage of the new hire’s base salary as a retainer fee, which can run anywhere from 15 to 25 percent.
Once your new team member has been hired, they’ll need to be onboarded, which can result in additional costs to your business (including training, labor, and human resources costs).
Factors that play into employee cost: Overhead
No matter what business or industry you’re in, your employees need certain things in order to do their job properly—which is why overhead is another factor that comes into play when calculating the true cost of an employee.
The actual cost per employee will vary based on your business type, but standard overhead costs include:
- Rent. If your employees work in your office, you’ll need to rent office space. And as your team grows, you may need a larger office—which can result in higher rent.
- Utilities. Again, if you rent office space, you need to think about utilities, like electricity and water—and generally speaking, the more people you have on your team, the higher you can expect your utility bills to be.
- Office supplies. You need to supply your team with the tools they need to do their jobs, whether that’s laptop computers, pens and paper, or industry tools—all of which play into your total overhead costs.
- Operating costs. As an employer, you have to pay for a variety of operating costs, like running payroll—and those costs can vary based on your total employees.
- Off-site overhead. Even if you don’t have an office, you might have overhead costs; for example, you might give your team members a stipend to cover rent at a coworking space or pay for a portion of their utilities if they work from home.
Factors that play into employee cost: Overtime
If you employ non-exempt employees, if they work more than a certain number of hours per day or week (laws vary by state), they’re eligible for overtime—and if they end up clocking overtime you didn’t plan for, it will drive up their employee cost.
Factors that play into employee cost: Payroll taxes
As a business owner, you’re responsible for paying a few different types of payroll taxes for your employees:
Federal Insurance Contributions Act (FICA)
The Federal Insurance Contributions Act (more commonly known as FICA) covers both social security and Medicare taxes for your employee. The current FICA rates for employers are 6.25 percent of taxable wages per employee per year for social security and 1.45 percent for Medicare—for a total of 7.65 percent.
The one caveat? Social security taxes only apply to taxable wages up to $137,700—so the maximum an employer will pay in social security taxes in 2020 is $8,239.80 per employee.
Federal Unemployment Tax Act (FUTA)
Employers are also required to pay taxes for the Federal Unemployment Tax Act—also known as FUTA—which helps to pay for benefits for unemployed workers. If you pay more than $1,500 in wages to your employee, you have to pay FUTA taxes on an annual basis; however, FUTA only applies to the first $7,000 of wages for each employee.
According to the IRS, the standard FUTA rate is 6 percent; however, businesses who file an Employer’s Annual Federal Unemployment Tax Return (Form 940) may qualify for a 5.4 percent tax credit—bringing your total FUTA tax rate to 0.6 percent.
In addition to FUTA, individual states also have their own unemployment tax rates, which vary by state—and can dramatically increase or decrease your employee costs. For example, in 2017, the maximum state unemployment tax rate in New Mexico was 5.4 percent, while the maximum state unemployment tax rate in Wisconsin was 12 percent—more than double.
Certain cities, counties, and jurisdictions also impose additional taxes on businesses, which can raise your total cost per employee.
Factors that play into employee cost: Workers’ Compensation insurance
Employers are required to pay for workers’ compensation insurance for their employees; that’s a non-negotiable. But how much you pay in workers’ comp per employee will depend on the type of business you’re in.
Typically, the higher the risk of your employees getting injured on the job, the more you can expect to pay in workers’ compensation insurance. Workers’ comp is typically regulated by the state, with each job classification being assigned a rate per $100 of payroll (salary or hourly wages). The riskier the job, the higher the rate.
To give you an idea of the range you can expect to pay in workers’ compensation insurance, here are a few examples from the National Council on Compensation Insurance:
So, as you can see, you might pay as little as 0.12 per $100 for an office worker (who has a low risk of injury) or as much as $8.99 per $100 for a painter (who typically has a higher risk of injury)—so depending on your employee’s job description, your workers’ comp costs can vary widely.
Factors that play into employee cost: Benefits
Many companies offer a variety of benefits to their employees, especially if they want to attract top talent in a competitive market. But obviously, those benefits come at an added cost to the company—and can have a huge impact on employee cost.
The most common (and arguably most important) benefit employers offer to their employees is health insurance—but it’s not cheap. According to the KFF 2019 Employer Health Benefits Survey, the average annual premiums for employer-sponsored health insurance in 2019 were $7,188 for single coverage and $20,576 for family coverage. Small business employers paid, on average, 84 percent of the premium for single coverage employees and 60 percent of the premium for employees getting family health coverage—which would come to an average cost of $6,037.92 for single employees and $12,345.60 for employees with family coverage.
Depending on the percentage of your employees’ premiums you cover as an employer, you might be eligible for a Small Business Health Care Tax Credit, which can help bring down your health insurance costs per employee.
In addition to health insurance, you might want to offer your employees additional types of insurance, including:
- Dental insurance
- Life insurance
- Disability insurance
While the cost for these types of insurance is typically far lower than health insurance (and will vary by location and plan type), they still have an impact on the total employee costs.
Many employers also offer 401(k) matching, which is when you match an employee’s retirement contributions up to a percentage of their salary. According to Vanguard’s How America Saves 2019 Report, the average employer 401(k) match in is 4.3 percent.
So, let’s say you have an employee making $50,000 per year and you wanted to match their 401(K) contributions according to the national average; that would increase your employee cost by $2,150 ($50,000 x .043).
Paid time off (PTO)
If you provide paid time off—in the form of sick and vacation time—that will also impact the true cost of an employee. So, for example, let’s say you have an employee that you pay $25 per hour. If they worked 40 hours per week, 52 weeks per year, they’d be working a total of 2080 hours—bringing their total labor costs to $52,000. However, if they take 21 days of PTO, they would technically be working 168 fewer hours, for a total of 1912 hours. While their compensation would still be the same (since their time off is paid), their hourly labor cost to you as an employer would increase, to a little over $27 per hour ($52,000 / 1912 hours worked).
How Hourly can help you bring your employee costs down
Now that you know how to calculate total employee cost, the next challenge is to figure out how to bring that cost per employee down—and Hourly can help.
Hourly is the only people management tool that provides time tracking, payroll processing, and workers’ compensation—all from a single, easy-to-use platform. With Hourly, you can run detailed, real-time payroll reports, which can help you keep labor costs low—and could potentially save you thousands in workers’ compensation premiums. And because Hourly was designed with convenience in mind, you can access all the platform’s features (including processing payroll, issuing workers’ compensation certificates, managing shifts, and onboarding new team members) from your phone, on the go—and all for far less than you’d pay for a traditional payroll provider.
Want to experience for yourself how Hourly can help simplify the process of running your business—and help bring down employee costs in the process? Sign up for your free 14-day trial today!