Employee Cost Calculation: A Comprehensive Guide

Business employee man are reporting about performance graphs summary and financial budget calculations for managers in the office.

Employees are one of the most, if not the most, important assets a business possesses. They are also one of the most significant cost drivers for a business. However, employee cost calculations are not nearly as easy to figure as other costs related to business, including raw materials, overhead, and even marketing costs (which fluctuate quite heavily). There are several intertwined factors to take into account, but if you do it correctly, it may drastically improve your financial planning and control.

Employee Cost Calculation – Basic Elements

The three basic and most easily traceable/calculable employee cost elements are:

Salary/Compensation: The compensation or salary you offer to the employee. You can calculate it in flexible tiers like basic salary, insurance, allowances, etc.

Benefits: The government-mandated benefits or the benefits you offer to hire and retain the best talent also come with their own costs. This covers everything from contributions to the local social security plans to paid holidays you offer your employees, which may make a significant difference. For example, you have 50-employee processing plants in two countries, one of which requires you to offer ten paid holidays (public holidays) to the employees, while the other country requires you only to offer five. Assuming all other costs are the same, this benefit can significantly impact your bottom line and profits.

Bonuses and Commissions: Bonuses can be considered costs you have to pick up just to hire and retain the top talent. They may be financial year-end bonuses, commissions, performance bonuses, etc. These are variable costs that must be calculated concerning the benefit they are offering to the company, not in a vacuum.

Associated Elements

Several additional costs are associated with employees in general, and they should be tracked/calculated both collectively and individually. This is useful determining the ROI of benefits like private insurance. For example, the individual cost of private insurance may dilute as you add more employees to the payroll, even if the collective cost increases.

Other such elements include the cost of real estate. If you have more employees, you need more space. You will also need more furniture and amenities. If you offer meals (fully or subsidized), the cost would also have different thresholds based on how the number of employees.

It would also be wise to divide them into one-time versus running costs. One-time costs of employees include the hiring process and other associated costs. Like many other employee cost calculation elements, you can be as granular with hiring costs as you want. For example, the hours your HR team, department heads, and other employees focus on hiring could take away from their usual duties.

Therefore, dedicating a few days a year to the hiring process may be more cost-effective than dividing the process throughout the year for some companies. Hiring costs may include background checks and any outsourced element of the process. Other one-time costs may include additional hardware/resources you have to buy for employees, like computers/specialized equipment but keep in mind that their value as company assets typically overshadows their cost pertaining to the employee.

Running costs include overhead costs like premises, furniture, utilities, etc.

Factors Impacting Employee Cost Calculation

Several factors impact employee costs and, by extension, their calculations.

Geography: The geography of your business and your employees can make a difference in employee cost calculations. Compensation trends, benefits (under labor laws), cost of talent, cost of operating in the country, the citizenship status of the employees, etc., are just some of the many factors that impact employee cost calculations.

In some cases, it’s cheaper for companies to invite foreign workers/immigrant workers who may live independently (and have a lower cost of living) rather than tap into the local workforce. Calculating both options separately should help you run a better cost-benefit analysis. Hiring freelancers and contractors may allow businesses to circumvent some of these costs, but each country has different requirements for those categories. You can also use employer of record (EOR), such as Engage Anywhere, which is a third-party company that takes on the responsibility of being the legal employer of a company’s workers, so your business can hire the employee without having to set up a legal entity.

Mode of Working: Remote versus on-site work come with different costs and efficiency considerations. Companies with larger workforces can significantly reduce their overhead costs by switching partially or fully to remote work. The difference may be enough to cover efficiency deterioration by hiring more employees without hurting the bottom line. 

Skill: The skills of employees are a significant cost consideration. Hiring expensive but highly skilled employees may seem like a costly decision, but the cost may be worth it if it increases the chances of success and on-time completion of tasks and projects. Similarly, paying top-dollar for skills made redundant by technology (or in the process) just because of the right certifications or credentials may not be a cost-effective solution.  

Industry and Nature of Job: Some industries and specific jobs in all industries simply command higher pay. Employees for offshore rigs, for example, cost more from every angle, i.e., from compensation to overhead. One-time automation costs may significantly reduce the running employee costs for an offshore rig over the lifetime of operations.

Unions: Unions and collective bargaining can significantly increase employee costs, especially if not managed properly. For example, a five-day strike to only knock off one-percentage point from the 8% raise your employees were looking for may cost the business more (in annual expenses) than agreeing to the original number in the first place.

Market Conditions: Employees cost more when your profits are down for the same amount of work. But if you cut your workforce every time your profits drop, you may not be able to attract or retain top talent, which comes with its own cost considerations.

Efficiency/Performance Management: The more efficient your workforce is, the better it is for your employee cost calculations. Employees don’t necessarily have to cost less. They can balance the scales by doing more.

Retention: Retention and turnover have a significant impact on employee cost calculations. If you can’t retain your employees for relatively long periods or if you do, but their efficiency goes down as a function of time, they would slowly turn from assets to liabilities. So, retention is a cost factor that should be considered through the efficiency lens. Loyalty is important, but keeping irrelevant talent in the firm out of loyalty may not be an effective costing decision.

Several other factors may differ from country to country and industry to industry. Technological innovation is also a significant factor in the employee cost calculation. A technology that may allow you to reduce a hundred to two dozen staff may be worth considering, even if the upfront cost is massive.

Conclusion

Employee cost calculation can be as granular as you want, but digging too deep may be futility. Monitoring some of the most significant cost drivers and associated factors is essential.

It’s also important to leave room for anomalies in your employee cost calculations, which may include drastic changes in labor laws, new competitors entering the market and pulling talent away, and technological innovations that trigger radical changes in your business model (like AI is doing to certain industries right now).

Accurate employee cost calculation (and associated decisions) can set up your business for long-term success. Want to stay up-to-date on the latest employee management and global compliance strategies? Check out our blogs for expert insights and practical tips for your growing business.

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