If you own or managing or growing business, there’s often a temptation to add another employee to assist with workload and — hopefully — fuel additional growth. However, any full-time employee costs a business more than their salary. Costs like payroll taxes, benefits, equipment, and training all need to be considered.
So what’s the true cost of adding another employee? In this article we’ll review factors that help you determine the true cost of an additional headcount and also help you determine whether the additional value justifies the full cost and whether you can support the outlay.
What Is the True Cost of Hiring an Employee?
The true cost of a hire includes that employee’s compensation, employer-paid payroll taxes, benefits, recruiting costs, onboarding, equipment, software licenses, and the time existing employees spend training or supervising the new person. Some of these expenses are ongoing and last as long as the employee stays with your company, while others occur only when they’re first hired..
How To Calculate the Total Cost of Hiring an Employee
To calculate the total cost a new employee, you need to total their annual salary as well as any likely bonus (if they’re eligible), as well as payroll taxes and other employment costs, employer-paid benefits, the cost of any equipment or software they’ll need to perform their role, as well as the cost of recruiting that new employee, onboarding or training, as well as the cost of other resources from across the organization that will go into training them.
Consider an $80,000 salaried hire. That employee’s base salary may only be $80,000, but employer payroll taxes will likely add another $7,000 to their total employment cost. Employer-paid benefits will likely add another $14,000. Depending on their role, that new hire may need equipment, software, or ongoing training that might total $3,000 or more.
These expenses compose that one employee’s total annual recurring direct cost of $104,000. If you add to that the costs of recruiting and onboarding that new employee ($6,000), that brings the total first-year cash and direct expense of a single new employee to approximately $110,000.
Note: Actual taxes, benefits, and other costs vary by location, benefit plans, and the specific role. This example also excludes the economic cost of management time. If a manager spends 100 hours onboarding and supervising the new employee, those hours have an opportunity cost that must be considered.
Account for Onboarding When Hiring a New Employee
New employees never operate at full productivity when they first start. Suppose a new sales employee reaches 40% of expected productivity in their first quarter, 70% in the second, and 100% starting in their third quarter. Even in this case — where an employee has gotten up to speed fairly quickly — their total first-year contribution will still be below a full year’s of an existing employee.
Once you account for new employee training, mistakes they’re likely to make when they first start, slower delivery times, and the work that existing employees temporarily absorb, the costs of a single new employee — even one focused on producing new sales — are even higher.
How Much Additional Revenue Will a New Hire Generate?
For many organizations, new hires aren’t focused on sales and will therefore never generate incremental revenue. Some may help take on tasks that free up time and resources for employees who are focused on producing revenue. For a role expected to generate incremental sales, here’s a helpful starting point:
Breakeven incremental revenue = Incremental annual cost / Contribution margin (as a percentage)
If the incremental annual cost of a new employee at an organization is $110,000 and all additional sales at the organization produce a 40% contribution margin, the business needs approximately $275,000 in additional revenue to cover the cost of that new employee.
However, as discussed, not every role generates revenue. For operations, finance, or customer support roles, you’ll need to measure capacity created from a new hire, overtime avoided, improved service quality, customer retention, errors prevented, or time freed for higher-value work.
Alternatives to Hiring an Employee
Before approving a new full-time headcount, compare the total cost of a new hire with some alternatives. Alternatives to a new full-time employee include using contractors, investing automation, improving existing processes, redistributing work, or delaying lower-priority activities.
A contractor may appear to cost more per hour but may actually cost less overall once total costs are considered. A full-time hire may make more sense when work is sustained, specialized knowledge matters, and utilization will remain high.
Can the Business Afford the Cost?
A hire can make long-term sense for a business and still create near-term strain. To determine whether a business can afford the cost of adding a new employee, add payroll, recruiting, benefits, and setup payments to your 13-week cash flow forecast. Check the lowest projected cash balance to make sure a new hire will push your balance negative in any single week.
Seven Questions Before Adding Headcount
Before deciding whether to add a new full-time hire, here are a few questions to consider:
What specific organizational limits or constraints is the hire intended to solve?
How much work is available for the new now, and how reliable is future demand?
What is the complete recurring and one-time cost?
How long until the employee reaches full productivity?
What additional gross profit, savings, or capacity will result from adding a new employee?
What alternatives could solve the same problem?
What happens to cash and profitability if demand falls short?
The Bottom Line
A model can’t make the decision for whether to hire a new employee. But, it will expose the assumptions underlying the decision — things like demand, utilization, onboarding time, incremental margin, and cash requirements. This makes it easier to hire when the expected value and organizational needs justify the cost of a new employee.
If you want to learn more about using data to improve hiring, schedule a free consultation. We’ll explore what data you have available and discuss ways you can use that data to make better decisions about your business.
