What is the True Cost of an Employee and How to Get Most of Each?
Did you know that the amount you have marked off for the salaries of your employees is not the true and final cost?
It is always at least 20% more or in other words 1.2-1.4 times more of your employee’s yearly salary when estimating the true cost. Тhis is valid no matter the location, area of expertise, the year we are in, nor if it refers to the professional or manufacturing industry.
Very useful calculators or cost per hire calculators exist where one can pretty quickly sum up total costs for one employee.
A great question to begin with is:
Why do employers hire employees in the first place?
Employees are hired to help the businesses bring more money or more value. Since they are hired to contribute, employees have a task which brings certain value to their employer.
In reality, not every hour of employee’s work will contribute to the business. The time that is spent on creating value is between 40-80% which is ok and expected, but the rest is still a cost. Interestingly, this is not true for freelancers. Their utility time is full – 100%.
When business grows, you need to hire new people.
New hire often decreases sales in short term as they learn the job. Sometimes you may even lose a client or two depending on the type of the job.
It will take from 8 to 26 weeks or the new employee to achieve their full productivity. During this time you lose money, as they cost more than they are earning. Only afterwards, when they start triving, you are getting to your break-even point.
Associated costs are the most obvious, but mostly overlooked as they are not the ongoing costs. They only occur when you hire someone. They include:
- advertising costs
- recruiters salaries
- for high-level jobs relocations costs
- background check
- pre-employment assessment
- and others.
For example, new employees on the high-corporate jets will go through full background check and drug screening.
Other associated costs of hiring
So, the employee is hired. That is done. What now?
Yes, there is training to be done.
This is one of the most expensive investments you will make.
Employers spend 32 hours every year on training. With some of the training done online, the costs are reduced, but this cannot be done for all areas and jobs.
Once hired there are costs which include ongoing costs – insurance plans, pension plans, holidays & vacations, gym memberships, sick days, taxes, payroll, overtime payments, office parties and others.
Another is the cost of integration or assigning a new hire an office space, utilities, software licenses and other ways of enabling them to fit in and get along with others. Many organizations goa an extra mile and enable an ergonomically-designed chair or desk, cell phone, travel fund etc.
Taxes are the major expense for every company and every worker you hire represents an additional tax burden on your company. As an employer, you have an obligation to pay your share of social security and health insurance. Additional federal, state and local income taxes are included.
This is crucial for some businesses, for others it is not. For a person who works in an office space there is no need for additional, personal adjustments. IT specialists often need their cell phones, they may need tablet computers to test equipment or similar.
How to avoid these costs?
It’s hard to figure out the exact cost of hiring, but if you do it 1-2 times a month it’s worth the effort. There are few solutions to avoid these costs:
- Offering the incentives to your employees for the referrals, to avoid the bad hire.
- Another way to save is to hire within the organization, although this may leave a gap in some other department of your organization.
- All together, focusing on hiring entry-level employees and moving more experienced one up the ladder may bring solution to all the burdens as recruitment costs are lower for entry-level positions.
In many cases there is very painful experience especially when an amazing employee leaves, when someone popular from the office departs, or just the stress of having to pick up the work of someone who exits unexpectedly. Again, you need to hire new people. This is called employees turnover.
According to the Josh Bersin, the cost of losing an employee includes many costs: cost of hiring, onboarding, lost productivity, lost engagement etc. Luckily, New hire can progress from a COST (-) to becoming an extremely valuable ASSET (+). Actually, this is true only if the employee stays long enough within the company. In other words, they get more productive the longer they are at the company.
Maia Josebachvili made a calculation of the Employee Lifetime Value which represents the total value that employee brings to an organization.
On the other hand, Jack Altman proposes that we can calculate costs of employee turnover by calculating the four main routes:
- Cost of hiring (a replacement)
- Cost of onboarding and training
- Cost of learning and development
- Cost of time with unfilled role.
Reducing the cost of employee turnover
If you are interested in how to survive the turnover, there are not too many options.
Actually, only two main possibilities for it:
1-Reducing the turnover itself
And how can we do that?
Based on Jack Altman’s advice:
The organization should focus on growth, impact and care in order to reduce the employee turnover.
What this means in practice, is for the employers:
- To have conversations with employees about their goals
- To give them more responsibility
- To help them acquire new skills to encourage growth
- To articulate a clear and purposeful company mission to clarify the impact each employe will have
- To build culture that show care and appreciation.
2-Reducing the costs of the turnover when it occurs
Maia Josebachvili suggest to maximize the Employee Lifetime Value by achieving these four principles. They involve minimizing the time where the employee is the cost and maximizing the potential where the potential of the employee through good management:
- Onboarding – a good onboarding program reduces the time it takes to employee to become a fully contributing member and it significantly increases the chances for the employee to stay within the organization long-term.
- Hiring – an excellent hire has a higher maximum output from the beginning, plus attracts and elevates other top performers.
- Management & Development – great management and development practices increase the value that the employee brings to the organization over time.
- Management & Culture – strong management practice and positive culture are in direct correlation with retention.
Bad hire costs
This can happen sometimes too.
You think you have calculated everything and have everything under control when hiring. But, how much can you predict a bad decision, a bad hire and all the associated costs?
But not only the costs.
Bad hire can cause also less productivity, negative impact on client solutions, additional lost time to recruit and train. On the contrary, making a good hiring decision not only increases employee retention, but also reduces all associated, negative impacts.
Bad hires usually happen due to need to fill in the job quickly(38%), sometimes you just make a mistake (34%), insufficient talent intelligence (21%), didn’t check references (11%).
In order to avoid them, take a fresh look at the job description and compare it to your current needs, try to listen more closely during the interviews, seek help from your colleagues and ask for their opinion and advice, offer above-average compensation, hire for fit (know their competencies, but also confirm how your candidates may fit your corporate culture and existing team).
Once you choose to terminate an employee, you can expect costs.
If the employee is laid off, separation costs are avoided. If the separation is the performance-based, all the potential time of the HR and management on counseling, deliberations and termination are avoided.
Sometimes, simply by using contractors, all these potential risks for costs could be avoided.
These are the most difficult to quantify. It includes the cost of time spent on managing employees from a human resources perspective. You will have to hire, fire, coach, train and police them. On average 2 hours per week per employee.
Generally speaking, this consumes almost 15% of the manager’s time, but 25% of total employee costs.
Decision makers usually think that using consultant will not cut the management costs. The truth is, this is not the main point in the first place. The most important is that the manager’s time could be spent on high impact decision making and value creation instead.
Costs of mistakes
Employees make mistakes with zero consequences or costs and the 100% of burden is on the employer.
And yes, they will make mistakes.
Employees will break and damage raw materials, waste materials, not answer the phone and the list go on (you can list your own) and guess what —> you cannot charge them for it.
It is clear that this varies with each and every type of the business. There is also no formula for calculating these costs in advance.
Absence or replacement costs
Your employee will take at least 20 days a year for either vacation, personal and/оr sick time. This means you will be paying your employee, even when it’s not doing any productive work.
Specific kind of leave is maternity leave in case one of the employees gets pregnant, adopts a child or need to take care of sick parent or relative. Laws in those cases require you to keep the place empty until employee resolves its current situations.
Ways to go around this is to either having your other employees for short time which will cheat their own responsibilities or by taking your higher value time or having new, temporary employees that cost double or triple of your employee salary.
What are your ways of covering the absence of your employees?
Costs of work related injuries
When an employee gets injured during the work the associated costs are both to the company and the employee, including medical bills and decrease in productivity. Often, these costs are affecting the family of an employee, other employees and customers.
The American Payroll Association estimated that theft affects 75% of the small businesses. An employee survey calculated that employees are stealing around 4.5h per week. Per employee! It seems ridiculous, but the numbers are there.
Time theft includes the following:
- Late starts
- Early finishes
- Long breaks
- Buddy punching – when colleagues clock in for each other when one is running late or is absent entirely
- Unauthorized overtime
- Personal activities at work
It may seem rather random event, but let’s take a closer look.
As a solution there are two main approaches: a combination of technological factors and human resource factors.
Technological aspect includes attendance softwares or biometric clocks or many other solutions. Even so, these solutions do not help with motivation and engagement.
HR practices have tried to motivate and encourage better on the job performance. As these programs do no include the financial aspect, they mostly fail.
Stock options related costs
There is a huge ongoing debate if this should be included in the income statement or not. What do you think about it? Is this the cost?
Fun facts for the farewell
The first employee is the most expensive. The more you hire, it gets cheaper and cheaper.
The smaller the business, the higher the opportunity cost for an employer to comply with all the regulations and administrative burdens.
It seems like as you grow the the costs evaporate.
Despite the popular belief, job costing, labor tracking, and running payroll doesn’t have to be a distracting, time-consuming or complicated task. In fact, when you have the right tools in your virtual toolbox, you shouldn’t have to slow down at all-you just might even speed up.
How do you evaluate the costs of your employees?
Is there something we did not mention and you have discovered it in your own practice?
Feel free to suggest and comment.
You Teodesk team!