How Much Revenue Do You Need Before Hiring an Employee?
Business is booming. There’s more work than you can handle.
Is it time to hire an employee?
Entrepreneurs often face this difficult question. Hiring a new employee can help increase productivity and boost sales. But growing your team comes with real costs, including salary, taxes, and recruitment expenses.
So, how much revenue does a small business owner need before they can justify the cost of hiring an employee?
Here’s what you need to know.
Table of contents
How much does it cost to hire a new employee?
Hiring a new employee costs more than just a salary.
There’s a rule of thumb that the cost is typically 1.25 to 1.4 times the salary, according to the Small Business Administration.
So the salary-plus-benefits package for an employee who makes $50,000 a year would equal $62,500 to $70,000.
It’s important to create a hiring budget and consider the financial implications of bringing on a new team member.
Some experts suggest having at least six months worth of operating expenses saved up before hiring your first employee. This provides a financial cushion that can help cover unexpected costs or dips in revenue.
Jeremy Eppley, a fiduciary financial planner at Silverstone Financial, said small businesses need enough revenue to cover the following before hiring an employee:
- The amount they pay themselves
- Business expenses/overhead
- New employee compensation
- Costs associated with hiring an employee (training, equipment, etc.)
- Enough profit margin to absorb future profitability fluctuations
That last point — keeping a financial buffer — is especially important.
“Otherwise the business owner may need to let the new employee they just hired go if the business hits a cold streak,” Eppley told Business.org.
How much should you pay an employee?
Salary is the biggest cost associated with hiring an employee. Depending on the industry, the average salary for a full-time employee can range from $30,000 to $80,000 or more.
Aside from salary, small business owners are also responsible for paying taxes, workers compensation insurance and possibly health insurance.
These costs can quickly add up to about 40% to 80% of your business revenue.
Determining the salary of a full-time employee isn’t an exact science. You need to consider several factors.
- Average pay: Research the going rate for the position you’re hiring for to ensure it’s competitive. The Bureau of Labor Statistics provides average pay rates for different industries and regions. PayScale, Glassdoor and LinkedIn also publish reports on salary data.
- Geographic area: The average pay for the same position can vary widely depending on the area and the local labor market.
- Candidate pay expectations: Potential hires also have expectations of how much you should pay them. It’s essential to enter salary negotiations with a range in mind so that you stay within your company’s hiring budget.
- Labor laws: The federal minimum wage for nonexempt employees is $7.25 an hour, but that number can vary from state to state. Make sure you’re familiar with the state minimum wage laws where your employee is located, especially if you’re hiring for a fully remote position.
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Costs to expect when hiring a new employee
Aside from salary, small business owners should also consider the costs of payroll taxes, any equipment the employee needs to perform their job, training materials, and the loss of productivity while the employee is being trained.
Hiring a W2 employee means setting up payroll taxes. It’s best to consult an accountant to understand the full tax implications, but here’s a brief overview.
- FICA: Employer share of Federal Insurance Contributions Act (FICA) tax: 7.65% on compensation up to the annual wage base, which is $160,200 in 2023.
- FUTA: Federal unemployment tax (FUTA) of $420 per employee: The FUTA tax rate is 6%.
- State unemployment tax: This varies by state. Employers who also pay their state unemployment insurance can receive a federal tax credit of up to 5.4%, resulting in an effective FUTA tax rate of 0.6%.
- Employee withholding: You must withhold and submit federal and state income taxes from your employee’s paycheck. In some states, like New Hampshire, withholdings are still required even though people don't pay income tax.
Paying your payroll taxes is really important, said Robert Persichitte, a certified public accountant at Delagify Financial.
“If you have to choose between paying your business taxes or paying your payroll tax, choose the payroll tax,” Persichitte told Business.org.
Why? Because payroll taxes are technically part of employee compensation. Failing to pay the proper amount equates to wage theft in the eyes of the IRS, which can result in fines and criminal prosecution.
Insurance and Benefits
Under federal law, only large employers with 50 or more workers are required to provide health insurance to employees.
However, small business owners who provide at least 50% of the cost of health coverage to employees can benefit from a federal tax credit. Offering health insurance is also a great way to attract qualified candidates.
Other employee benefits include:
- Family and medical leave. Employers with 50 or more employees must provide eligible workers with up to 12 weeks of unpaid leave per year for certain family and medical reasons.
- Workers’ compensation. Workers’ compensation insurance is required in all states. Employers are required to provide this insurance, regardless of the size of the business. Costs vary from state to state.
- Paid time off. While there’s no federal law that requires employers to provide paid time off (PTO) to their employees, many states and cities have passed laws that require employers to provide a certain amount of PTO each year.
- Retirement plans. Many employers are not required to offer retirement benefits. However some states now require payments into retirement accounts or paid medical leave accounts.
If you offer employee benefits such as health insurance, life insurance, or a retirement plan, take the costs of providing these benefits into account. The cost can equal 20% to 40% of an employee’s wages.
Recruitment and Training
The average cost of hiring an employee is around $4,000, according to a study by Glassdoor.
Job posting fees, candidate screening tools, background checks, new equipment, and training programs are just some of the costs that factor into hiring a new employee.
Consulting with a human resources firm or temp agency to help you find your new hire also comes at a price.
You might be able to train a new hire yourself, but you need to consider how much time it takes away from generating revenue. Companies spend an average of 46.7 hours training an employee, according to a report by Training Magazine.
Make sure to calculate training and onboarding costs when doing a cost-benefit analysis. Factor in ramp-up time as well. After all, your new employee won’t start generating money for your small business on day one.
Consider Contract and Freelance Roles
Hiring a full-time employee isn’t your only option.
Bringing on a freelancer or contract employee can be more cost-effective, particularly if you only need help for a certain project or during a specific time of year.
Because contractors are self-employed, they pay their own taxes. That means less paperwork and hassle for you.
You can find contractors and freelancers on sites like Indeed, Fiverr, Upwork, and LinkedIn.
Here are some of the pros and cons of opting for a freelancer or contractor.
Pros of Contractors and Freelancers
Payroll is easier with a 1099 contractor than a W2 employee. Instead of using a payroll provider, you simply supply your contractors with a 1099 form at the end of the year stating the total income you paid them.
“Your bookkeeping software, like QuickBooks, should be able to populate that form for you,” Eppley said.
Another major perk: Most 1099 positions don’t require benefits like family leave or health insurance.
Businesses that rely heavily on technology may also be able to save money by investing in software or automation tools instead of hiring additional staff.
Virtual assistants are another option. These contractors can save small business owners time by completing clerical tasks, such as responding to emails and filling out paperwork.
If you opt for a virtual assistant, Eppley recommends reaching out to small companies with less than 10 employees that specialize in your industry.
“The best way to find these small niche virtual assistant companies is to ask for recommendations on an industry community forum or online network,” he said.
Cons of Freelancers and Contractors
You’ll pay a higher premium for the convenience of a freelancer.
Since they’re self-employed, contractors have to withhold their own taxes and provide their own health care. Those extra costs often get baked into the fee they charge you.
“A contractor could cost $50 an hour, while you could hire someone full-time for $12.50 an hour,” Eppley said.
It’s also difficult to create a strong company culture with contractors because they don’t have the same personal buy-in to your business.
“This can make it harder to develop junior employees to take more senior positions in the future,” Eppley said.
Are You Financially Ready to Hire an Employee?
While there are costs associated with hiring a new team member, potential benefits can make it a worthwhile investment. For example, hiring a salesperson can help increase revenue by attracting new clients.
So, how can you determine when you’re financially ready to hire your first employee?
One approach is to conduct a thorough cost-benefit analysis.
This involves assessing the costs associated with hiring and onboarding a new employee, as well as the potential benefits (and revenue) that the new hire could bring to the business.
Comparing the costs and benefits side-by-side will give you a clearer picture of whether the investment of a new employee is likely to pay off.
Cash flow is another important consideration.
Even if you have enough revenue to support a new hire, it's essential to have enough cash on hand to cover other expenses, such as overhead, training and new equipment.
If you crunch the numbers and simply can’t afford to hire a full-time employee, there are plenty of other flexible options, including freelancers, contracts and temporary or seasonal employees.
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