How Do I Calculate My Employees’ Total Cost?

As you’re growing your company, it becomes important to understand the cost of an employee. Figuring out what employees cost is a function of management accounting, sometimes called absorption costing, and can be a daunting task.

So, why do you want to find out how much employees cost?

There are four primary reasons to calculate the costs.

The first is budgeting.

As a service provider, labor is the largest expense line to your business. Figuring out the costs of the people you need to be able to provide the services your clients is a component of the budget.

Secondly, is pricing. If you are going to use that employee to service your customer that employee has specific costs associated with them. If you price your service less than the full cost of that employee, you lose money for every hour you serve your customer. While you might think this is a crazy idea, businesses routinely lose money on service lines by an incomplete understanding of employee costs.

The third reason you may want to know this is strategic planning. There may be a point where you are looking to improve service or reduce costs by outsourcing a component of your business.

It is impossible to know how much money you will save without understanding the full costs of your current option. Outsourcing is popular for so many companies but to compare costs with an option, you need to know what you’re currently paying. Oftentimes, the outsourced option is not nearly as expensive as what people thought because they are not counting the full cost of those employees in their current roles. You will not know until you count up the cost of your current strategy and compare it to the proposed strategy.

And the fourth reason you want to know (and the option many MSPs need), is to calculate the service line profitability.

Understanding your different service lines for an MSP is critical. The employees you have supporting those service lines is extremely important. If you place a high-cost employee in a low-priced service, you will lose money on that service.

The challenge for a manager is to match the high-value service and the high-cost employees to profitably serve your clients. This is the number one reason we see people interested in understanding the full cost of their employees so they can allocate their employees among the service lines that this employee specifically supports.

Now that we have established the why, how are we going to do this?

There are four major components to the costs of an employee that you’ll want to allocate.

The first is wages. This includes anything that ends up in the W2. It includes salary, bonus, commission, and any kind of other taxable compensation.

Secondly, include payroll taxes. These are specifically payroll taxes paid by the company. Don’t consider costs paid for by the employee such as the state income tax for the employee or federal withholding, focus on the tax expenses to the business. Payroll taxes such as FICA (Social Security and Medicare), federal unemployment tax, state unemployment taxes, and even workman’s compensation which functions as insurance but is essentially an employment tax to the business. Some states will throw in ancillary taxes for employees paid by the business. Those are also included in each employment tax.

The third cost to include is health insurance. Health insurance is an enormous expense to an employer. Include just the health insurance the employer pays for, not the employee copay.

The last of the four primary costs to include is retirement contributions. Include all matches paid to the employee’s retirement account. Do not include the employee’s contribution. If there is a profit-sharing component, that should be included for each employee.

In addition to those four, sometimes managers add in other costs. Training and development can be specific to employees, certain equipment, and sometimes perks like gym memberships, meal allowances, and similar expenses given to the employees business included in costing.

While it is not uncommon to include these, the four primary costs to include in understanding employees’ full costs are wages, payroll taxes, employee insurance, and retirement contributions.

Add all the costs together and calculate the cost per unit of time to compare to the given revenue.

After you have calculated all these costs for each employee, divide them by the number of hours worked by the employee. Be sure to allow for sick time, vacation and training in your assumptions. This gives you the cost per hour worked, which you can use to understand your employees’ full costs.

The full costs of an employee are extremely important to know for your business. Employers use this information for budgeting, pricing, strategic planning, and service line profitability. Knowing these costs is essential to profitably managing your service organization and the best managers understand this number.