For many business owners, labor costs will be the highest expense that they endure. Businesses cannot operate without employees, and those employees result in a large percentage of a business’ expenses. The cost of an employee is not just what you pay them hourly or weekly. There are so many other factors that are intertwined with each of your employees. So, what is the true cost of an employee?
At Paper Trails, we consider ourselves a valuable resource for your business, providing you with the tools and knowledge to successfully manage your business and employees. We understand that labor costs are a significant concern for business owners, and that’s why we are here to help you navigate this complex aspect of your business.
When it comes to the true cost of an employee, it goes beyond just their hourly or weekly wages. In this article, we will break down all of the costs associated with each of your employees, providing you with a comprehensive understanding of the financial impact they have on your business. We will delve into areas like employee benefits, including health insurance and retirement plans, as well as payroll taxes and other mandatory contributions. Additionally, we will discuss the hidden costs of employee turnover and the expenses involved in recruiting and training new staff.
By the end of this article, you will not only have a clear understanding of the various costs employees have on your business, but also gain valuable insights into how to effectively manage and optimize these expenses. Our goal is to empower you with the knowledge and strategies needed to make informed decisions that will ultimately reduce your labor costs and improve your overall business profitability.
What is the true cost of an employee?
The most obvious cost of an employee is what you pay them on an hourly or salary basis. Whether or not you pay your employees hourly or salary depends on how you classify them. Be sure that you are classifying your employees correctly as either a non-exempt (hourly) or exempt (salary) employee. You can read the differences between the two types of employees here.
There are many other factors that go into the overall cost of an employee. Each business scenario is slightly different, so all of following factors may not apply to every business, or there may be additional unique costs in your particular industry. The most common additional costs include:
- Payroll taxes
- Workers compensation
- Benefits
- New employee recruiting and training
- Equipment and tools
- Licenses and certifications
- Labor laws
Continue reading below for more detail on each topic.
Payroll taxes
As a business owner with employees, you will be responsible for complying with payroll tax laws for each employee. Payroll taxes consist of two things:
- First, deducting a portion of your employees pay to pay the tax liability on their behalf. This includes:
- federal and state income tax based on your employees’ W4 form.
- the employee portion of social security and Medicare taxes.
- Secondly, paying the company share of payroll taxes on each employee. This includes:
- FICA taxes: social security and Medicare taxes.
- state and federal unemployment taxes.
Overall, most small businesses pay about an average of 10% of employee wages in required payroll taxes on top of the wages they pay to employees. For example, if you pay an employee $50,000 per year, that employee will cost you about $5,000 in tax liabilities. These taxes are divided up and cover a number of items including:
- Social Security Tax
- Medicare Tax
- State Unemployment Tax
- Federal Unemployment Tax
Workers compensation insurance
Workers’ compensation is regulated on the state level, and each state has its’ own requirements and penalties. Nearly every state requires employers with one or more employees to carry workers’ compensation insurance. Many states allow employers to purchase this insurance through private companies and have strict penalties for non-compliance. The insurance is used to cover things like:
- Lost wages
- Medical bills
- Rehabilitation
- Job retraining
- Disability benefits
- Funeral services
Each business pays a different premium for workers compensation insurance. The final amount is based on the business’ gross paid wages and employee job classification codes. Therefore, the more employees you have, the more wages you pay, the higher your workers’ compensation insurance will be. According to data by AdvisorSmith, the average cost of workers’ compensation insurance is $936 per employee per year. The rate for workers’ compensation insurance varies considerably based upon the state, the type of business, how long the company has been in business, and the number of workers’ compensation claims a company has had. According to the Bureau of Labor and Statistics, workers’ compensation premiums accounted for 1.2% of the total cost of employing the average American worker.
Benefits
Fringe benefits are a great way for employers to help attract and retain top talent in a competitive market. However, these benefits increase costs for employers. Benefits are an extremely important thing for employers to offer, but they must know and manage the costs associated with them to help their bottom line. Examples of benefits that employers offer than could result in added financial costs include:
- Insurance (health, dental, life, short term, long term, etc)
- Retirement plans
- Paid time off
- Bonuses
- Wellness plans
- Company cell phones
- Educational reimbursements
- And more
Based on statistics from the Bureau of Labor Statistics, employee benefits for private industry employees can cost an average of $12.02 per hour, or 29.5% of the average cost per employee. The below table breaks down the costs of certain benefits for employers. The highest portion of this number results from insurance, paid leave and other legally require benefits. Even some of the benefits that are non-traditional among business, like wellness programs, can have a big impact financially on employers.
| Average Employer Cost Per Employee | ||
|---|---|---|
| Wage Component | Total Cost | Percentage of Cost |
| Total Compensation | $40.79 | 100% |
| Wages and Salaries | $28.76 | 70.5% |
| Total Amount of Benefits | $12.02 | 29.5% |
| Paid Leave | $3.04 | 7.5% |
| Supplemental Pay | $1.52 | 3.7% |
| Insurance | $3.01 | 7.4% |
| Retirement | $1.39 | 3.4% |
| Legally Required Benefits | $3.06 | 7.5% |
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New employee recruiting and training
One of the hidden costs of each employee was the amount spent on the recruiting, hiring and onboarding processes. Many employers use third party recruiting companies to help source talent. If doing this, the costs can be more easily calculated. However, even if your business doesn’t outsource recruiting, there is still a cost for your employees to write detailed job descriptions, perform multiple rounds of interviews, check references, and more. This can have a big impact on your daily operations as your team is tied up with these administrative tasks.
Once a hire has been made, the employee onboarding process is also costly to employers. This process takes time away from your current employees in the form of training. Extra work and time away from their daily tasks will impact your bottom line.
According to data from the Society for Human Resource Management (SHRM), the average cost per hire was nearly $4,700. This is why it is critical for your business to have strong recruiting, hiring and onboarding processes in place. You do not want to waste time and money in hiring and training a new employee just to have them leave after a few weeks.
Equipment, tools, licenses and certifications
Employees across many industries require certain equipment or licenses to perform their job. This could be true of a carpenter who needs a hammer and nails, or a firefighter who needs certain trainings. These items can be an added cost to employers. Whether it be expensive software or more affordable tools, these can add up for each employee per year. Some examples of equipment and tools include:
- Laptops and monitors
- Printers
- Cameras
- Uniforms
- Tools like hammers, screwdrivers, etc
- Company parking
- Company cars
- Cell phones
Further, employers may have to, or decide to, pay for certain licenses and trainings that is required for their employees. While this expense is mandatory, and beneficial, to employers, the total can be a significant burden for small businesses. Research shows that the average cost for tools, equipment, licenses and more can be anywhere between $500 and $5000 per employee per year depending on your industry.
Labor laws
The last topic we will cover in this article is the financial impact of certain labor laws. Labor laws are changing rapidly in today’s world and many of them come with added costs for small businesses. In Maine alone, there are a handful of new challenges that have been enacted in the past few years.
First, Maine’s Earned Paid Leave Law required employers to give employees at least 1 hour of time off for every 40 hours worked. Businesses can, and many do, offer more, but providing time off to employees and having to pay others to cover those hours is a huge liability on employers.
Second, Maine’s vacation payout requirement ensures that employees are paid for any accrued and unused vacation time regardless for the reason of separation. While this is a great thing for employees, you can realize the financial impact on an employer that has to pay out 80 hours of vacation time to an employee when they leave.
Finally, with the forthcoming implementation of Maine’s Paid Family Medical Leave, employers will have to contribute a payroll tax of 0.5% of employee wages to help fund the program. For example, if a business pays $500,000 in payroll funds per year, their PFML liability would be an additional $2,500 that was not a worry before.
Conclusion on the true cost of an employee
Phew! That’s a lot of numbers and a lot of added cost for employers. While some of the added costs are required, and some are beneficial for employers, you must be aware of them to successfully navigate them. Now that you have finished this article, you should be fully aware that the true cost of an employee is more than just their salary. You should be aware of what to look for and what practices you need to put in place to make sure your company is financially stable moving forward.
If you have any questions about the above content, or need help managing and empowering your employees, feel free to contact us here!