The true cost of an employee includes all costs associated with hiring and retaining an employee. Understanding the total compensation of an employee goes beyond just the salary figure. Accurately determining this cost is essential for budgeting, financial planning, and making informed decisions about hiring and compensation.
Components of a Total Compensation Package
An employee’s total compensation package includes all monetary and non-monetary compensation and benefits that an employee receives. Knowing everything that goes into your employee’s total compensation package can help you retain employees and streamline your compensation planning. Let’s look at some examples of what is typically included in a total compensation package.
Salary
The first component of employee cost is the base salary or wage. This is the amount agreed upon during the hiring process. However, when calculating the cost of an employee, organizations are responsible for other expenses that extend far beyond the base salary:
Incentives
Employers frequently provide incentive pay to employees to encourage performance. Types of incentives may include bonuses, long-term incentives, options, equity payments, and other incentive programs can add to the overall cost.
Taxes
Organizations are responsible for paying employer payroll taxes. This includes Social Security, Medicare, federal and state unemployment taxes, and any local taxes. These are mandatory and vary depending on the country and state.
Benefits
Benefits can be a significant expense for some organizations, but it is crucial to offer. According to the Affordable Care Act, employers with 50 or more full-time employees, including full-time equivalent employees, must provide health insurance. Although health insurance is the most popular benefit offered, a range of benefits should be added to complete your total rewards package. Consider these additional benefits:
Paid Time Off (PTO) and Holidays
Paid leave policies are a significant part of employee compensation. Employees receive a predetermined number of PTO days that can be used for holidays not celebrated by the company or for personal time. Paid time off usually increases the longer an employee remains with the organization. In addition to PTO, include public holidays, when employees are paid but do not work, in the overall cost.
Perks
Offering additional employee perks will make your organization competitive and attract top talent. Consider these perks:
Factors That Can Affect an Employee’s True Cost
Several factors can affect an employee’s actual cost, including location, organization size, and recruiting costs, among others. At the same time, market trends in your specific industry may impact an employee’s total compensation. It is important to understand these factors to accurately calculate an employee’s cost.
Location
The employee’s geographic location must be considered since the cost of labor may vary significantly from one location to another. You may have employees working in multiple states or even countries, as well as remote employees. For instance, imagine your employer has its headquarters in San Francisco, California, and is opening an office in Dacula, Georgia. With the assumption that labor rates vary between these two locations, your employer will need to evaluate the cost of labor in Dacula, Georgia, to know the typical pay of employees in this new labor market. With the help of ERI’s Assessor Platform, organizations can analyze the cost of labor across multiple cities worldwide and adjust their compensation strategies accordingly to effectively compete for talent.
Market Trends
Understanding market trends within your industry is necessary to stay competitive. Compare your organization’s current compensation practices against industry benchmarks and competitor data to identify areas for improvement. Using various resources, such as compensation surveys, market reports, and reliable online databases relevant to your industry and geographical location, will help with this process. Consider using ERI’s compensation planning software to find market rates for jobs by location, industry, experience, organization size, and shift type.
Organization Size
Organization size has a significant impact on an employee’s true cost. Usually, larger companies provide employees with more benefits and perks as an incentive, meaning employees have a higher total cost. ERI’s Assessor Platform allows you to customize compensation analyses by organization size, which may be measured by revenue, assets, fiscal year budget (FYB), or number of employees.
Recruiting Costs
Finding the right employee for a role requires significant recruitment investments, whether you are using internal or external resources. These include the costs of recruiting staff and hiring managers for their time spent finding the ideal candidate. Consider these additional recruiting costs:
Onboarding Costs
After an employee is hired, they need to be equipped with the knowledge to contribute to their new role. Consider the resources and time that it will take for the new employee to settle into their new role. The average time for new hires to reach full productivity ranges from three to six months, which could potentially impact your team’s output or lead to a decrease in earnings.
Overhead Costs
Overhead costs are the expenses that a company needs to pay outside of labor costs. This can include building costs, property taxes, utilities, and office supplies, for example. To figure your overhead cost per employee, divide your total annual overhead costs by the number of employees.
Turnover Rate
Companies with higher turnover rates have higher overall employee costs because they are forced to invest in recruitment and onboarding costs more frequently.
How To Calculate the Cost of an Employee
There are multiple ways to calculate the true cost of an employee. One way to find out the actual employee cost is to add up all the costs incurred.
Step 1: Calculate Base Salary and Wages
Start by calculating the employee’s gross salary. For hourly employees, multiply their hourly rate by the number of hours worked per week and then by the number of weeks worked per year to get their annual salary.
Annual Salary = Hourly Rate × Hours per Week × Weeks per Year
Step 2: Add Payroll Taxes
Calculate the employer’s portion of payroll taxes. In the United States, this typically includes the following:
Step 3: Include Benefit Costs
Add the annual cost of the various benefits provided, including the employer’s contributions to health insurance premiums and retirement plans. Include any additional costs for other benefits and perks, such as professional development, bonuses, and other miscellaneous benefits.
Step 4: Factor in Paid Time Off and Holidays
Calculate the cost of any paid time off, including vacation days and sick leave, as well as public holidays. PTO cost can be computed as a percentage of annual salary based on the number of days provided.
Employee Cost Example Calculation
Let’s put this all together with a hypothetical example:
Total Cost = $60,000 + $4,590 + $5,000 + $3,000 + $3,462 + $1,000
Total Cost = $77,052
Thus, the true cost of this employee is $77,052 per year, significantly higher than the base salary of $60,000.
How Much Does an Employee Cost?
The typical cost for an employee is between 1.25 and 1.4 times the base salary. This rate includes costs for base salary, employment taxes, and benefits. When using this estimate as a guide, you can get the minimum and maximum cost for each employee.
Minimum cost of an employee = base salary x 1.25
Maximum cost of an employee = base salary x 1.4
For instance, if you hire a new employee with a base salary of $60,000, based on the calculations, the true cost of this employee is between $75,000 and $91,000. This formula gives employers an initial estimate of the real costs of employees, but the number can be tailored based on other factors determined by the employer.
Why Use ERI?
Manually calculating the true cost of each employee can be time-consuming and prone to errors, especially in larger organizations with many employees and complex benefits packages. ERI’s Assessor Platform can assist with this process, ensuring accuracy and saving valuable time. The Assessor Platform includes these valuable tools:
