When to Hire an Employee
When to hire an employee? What do they cost?
There are many reasons and different situations that require you to hire an employee. From needing an assistant, hiring a manager, or simply additional staff. When the time is right for your business based on capacity, you should know the costs associated with hiring an employee to make sure your financial situation can handle them. I will also cover the Labor Efficiency Ratio to help guide you when a new employee may be needed.
What do they cost?
When you hire a new employee, there are direct and indirect costs involved. The direct costs are payroll taxes, which include FICA/Medicare and Unemployment (both federal and state). The FICA/Medicare portion for the employer is 7.65%. For the Unemployment, I like to add about 1%. So, in total, the payroll tax is about 8.65% of the wages you will be paying the new employee. So, if you hire an employee with an annual salary of $50,000, the payroll taxes the company would be responsible for would be $4325. The other expenses you would have to figure when hiring a new employee would be the indirect cost associated. Those would include training, health insurance, retirement plan matching contributions, worker’s compensation insurance (unless it’s a high-risk industry, like roofing) and any other benefits your company may offer. I use 10% of wages for indirect costs as a good rule of thumb.
Use of Labor Efficiency Ratio to determine capacity
One number we use to help us determine capacity and when to hire a new employee is the Labor Efficiency Ratio. This is the Ratio of Gross Margin to total labor costs. So, if your Gross Margin is $300,000 and your labor cost is $150,000, your LE would be 2. Generally, we like to see in most businesses, an LE of 2.5. If you were in a more capital-intensive business, like manufacturing, it might be closer to 3.
Either way, as a benchmark, you would want to look at your industries Labor Efficiency. Looking at this number, we can use data to help us determine if we have capacity or need to start looking for new employees. So, if your Labor Efficiency is lower than 2.5, you probably have some capacity and need to gain some efficiency and not necessarily hire a new employee. If your Labor Efficiency is higher or at 2.5, this may be a sign that you need to hire.
At Core, before we monitored our Labor Efficiency, we FELT like we needed a new employee and had capacity issues. We hired the new employee, and they did not work out after a couple of months. Good for us! We dodged a bullet!! All this to say, when we started looking at our Labor Efficiency, we found it was too low, and we should not have hired anyone in the first place.
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Jeremy Doorn, EA for Core Group US