Growing your business series – Putting on a new employee

You've got too much work and not enough hours in the day - seems like this is the story of every business owner.  Lack of hours in the day doesn't discriminate, it affects us all in different ways.  So how can we find more hours in the day?  

In this blog post we'll be looking at putting on a new employee from a business perspective (we will cover the human resources requirements in a different post).  Let's look at the things we should consider before rushing in and hiring our next (or first) staff member.

Consider outsourcing (for when you need 20% of an employee ongoing)

Outsourcing might be the solution if you are just looking for a bit of help each week with no ongoing commitments. Hear me out, I’m not suggesting outsourcing your regular business activities to an overseas company, but outsourcing the business tasks that don’t make you a profit. Say you spend 5 hours a week on average in the office with your recordkeeping, invoicing, bank reconciliations, payroll and other office tasks. That’s, on average, 260 hours a year. If your charge out rate is $100 per hour, that is $26,000 of income you could be missing out on if you’re in a service business. If it costs you $6,000 a year for all those administration tasks to be outsourced, you’re still $20,000 a year better off!

5 hours a week is only 12.5% of a normal work week so let’s look at the next option…

Subcontracting (for when you need someone short term)

I don’t see subcontracting as a long term solution, but a band aid solution for when things get a little crazy. Generally, you won’t make big margins from using the services of subcontractors but you still seem to have to assume the same risks as employing someone yourself. It is important that if you do decide to use a subcontractor to help you get through things that you are hiring them for a result, not as a pseudo employee. Even if someone is subcontracting to you, it is possible to be caught under superannuation laws which means you will have to pay them super on top of what you are already paying them – and with tight margins already, this can make the costs exceed the income received from the work meaning you were better off not taking the job in the first place. 

Employing a staff member (for when you need someone long term)

As an accountant, everything is about the numbers. Before taking on a new employee I would want to have an idea of how much it’s going to cost my business, I’d want to know how I was going to track and monitor their performance and I’d like to know how much I need to charge them out at to make a profit. Let’s take a look at how we can answer each of those questions.

How much is it going to cost?

This one scares me a little. So often I hear, “this employee only costs me $700 a week”, which is their net weekly pay. Well, no. There are other costs that should be considered. Can’t forget about that PAYG tax that has been withheld from the gross pay. Let’s say we have $300 in PAYG that is withheld on that weekly wage. That means our weekly gross wages cost is $1,000. What about superannuation? There is another $95. Workcover? Staff Amenities? Staff Training? Annual and personal leave for permanent employees? This list isn’t exhaustive. As you can see, “my employee only costs $700 a week” has quickly become “I have under budgeted my payroll costs by more than $20,000 a year, per employee”. Once you have an estimate of your annual costs for your employee, whether you translate that into weekly, fortnightly or monthly will depend on the type of business you have. I would also suggest having an hourly cost of your employee. The hourly cost of our hypothetical employee is $27.38 and the weekly cost is $1,095, which is important in answering our next questions.

How am I going to track their performance?

Recently I watched a webinar for Business Growth and the presenter said, “You can’t manage what you can’t measure”. How you effectively measure the performance of your employee will vary greatly based on industry. You may track productive hours, number of sales, leads generated, average time to complete a task or number of units produced per hour. We’ll keep it simple and track productive hours in our hypothetical service business. Let’s continue our example from above and say our employee will be working and getting paid for 40 hours per week.

A recent study in America revealed that in offices, there is an average of 2 hours per day (or 10 hours per week) that is unproductive. That is a whopping 25% of time being unproductive! That is a lot of potential revenue missed so we need to be able to track and monitor our employees.

Continuing with our employee in the service industry, we want to consider some Key Performance Indicators (KPIs). Our employee will fill in daily timesheets, allocating the time worked to the jobs they worked on. From the timesheets we can measure productivity. Adding up all the hours charged to jobs each week, divided by the number of paid hours in the week will give us our employee’s productivity. 30 billed hours out of a 40 hour week = 75% productivity.

Another good KPI for an employee in the service industry is the labour recovery. This is the total billed out hours for the week divided by the total weekly cost of your employee which we calculated above. Our employee, with 30 chargeable hours at their hourly charge out rate of $100 an hour gives us $3,000 in income charged out for the week. The weekly cost is $1,095 which means our labour recovery for this week is 2.74 times. Not too bad. But what if we could improve their productivity by 10% so now we are getting 33 billed hours each week. That’s an extra $15,600 income per year for no additional cost. An extra $15,600 of pure profits, per year, per employee.

Now you may ask, how did I figure out to charge my employee out at $100 per hour? Well, for this example, I made it up, but that brings us to our next question…

How much do I charge my employees out at?

“Charge out rates are set by the market, the end.” I don’t know how many times I have been told that and I can’t disagree enough, though the market does provide you with a good way to measure your charge out rates. I’m sure everyone has heard the old adage, “you get what you pay for”. There is another similar saying that I enjoy a bit more, “if you pay peanuts, all you will get is monkeys”. My question to every business owner is, if you are providing a better service or more value to your customers than your competitors, why are you charging the same price or a lower price?

WARNING : LOTS OF MATHS AHEAD!

If your business has been operating for a while, you should have a rough idea of what your annual fixed costs are and a rough idea of how much profit you’d like to make for the year. Let’s say our annual fixed costs are $40,000 (not including employee wages) and we’d like to make an annual profit of $50,000. This gives us our target gross profit, $90,000. Our hypothetical service business is looking at taking on a second employee and we would like our employee to be responsible for recovering half of that $90,000. So we want a gross profit of $45,000 from our employee.

Our hypothetical employee who is going to cost us $27.38 per hour or annually cost us $56,940. We need to add this cost to the $45,000 of gross profit we want from our employee. This means, the total amount of revenue we need our employee to generate each year is $101,940.

In each year, that employee will have 52 working weeks but we lose 4 weeks to annual leave, 10 days to sick/personal leave, 2 weeks to public holidays and 104 days to weekends. This leaves us with, on average, 221 possible working days or 1,768 possible working hours (based on a 40 hour week – adjust this as appropriate for the number of hours your employee will work each week). We need to set our employee a target for number of productive hours per week. If we use the information mentioned above from the study in America, of the possible 1,768 hours in the year, 75% will be productive – this gives us 1,326 productive hours per year.

Now we have our target for revenue for our employee to generate ($101,940) and the number of hours for which they have to achieve it (1,326). This means our employee needs to have an hourly charge out rate of $76.88 to reach our goals. Easy right?

These are the questions that I think are important to ask before jumping in and hiring a new employee. The next important question, to which I don’t have an answer is, do I have enough work to hire an employee?