What Your First Employee Really Costs, Month by Month

Most owners decide they can afford a first hire by multiplying an hourly rate by hours per week. Twenty dollars an hour, thirty hours, six hundred a week. The business clears that comfortably on a good month, so the offer goes out.

Then the third month arrives with three paychecks in it, the state unemployment bill lands, and the new person is still only half as useful as they will be by summer. Nothing about the decision was wrong. The arithmetic was just done on the wrong unit. A hire is not a weekly cost, it is a cash curve that bulges early, dips in the middle of the year, and resets every January.

Why the weekly number misleads you

Three things push the real cash cost of an employee away from the simple wage figure, and all three hit hardest at the start.

The first is employer payroll tax. On top of the wage, you owe 7.65 percent in Social Security and Medicare matching, every paycheck, all year. You also owe federal unemployment tax (FUTA), which works out to 0.6 percent on only the first $7,000 of each person's wages if your state is in good standing, and state unemployment tax (SUTA) on a wage base your state sets. Both of those unemployment taxes are paid on the first slice of wages, so they are concentrated in the opening months of every calendar year.

The second is pay frequency. If you run payroll every two weeks, you have 26 paydays a year, which means two months contain three paydays instead of two. A $1,200 biweekly check becomes $3,600 of wages that month instead of $2,400.

The third is ramp time. A new hire usually produces very little extra revenue in month one, because you are training them, and that training comes out of your own hours.

One hire, worked through month by month

Here is the example I use with owners. A retail or service business hires one part time person at $20 an hour, 30 hours a week. That is $31,200 a year, or $2,600 in an average month. I have assumed a state with a 2.7 percent new employer SUTA rate on a $9,000 wage base, which is a common setup though yours may differ, workers' compensation at $1.50 per $100 of payroll, and payroll software at $55 a month. Month one also carries $650 of equipment.

Two things jump out. Month one costs $735.80 more than a normal month later in the year, almost entirely from equipment and the front loaded unemployment taxes. And the steady state cost of $2,892.90 is about 11 percent above the bare wage, which is the figure people forget when they say "it's only twenty an hour."

Now layer the paycheck calendar on top. The table uses averaged months. In reality, if your two three paycheck months fall in, say, May and October, those months carry $3,600 of wages instead of $2,600, and with FICA and comp that is roughly $1,090 more cash leaving than in a typical month. If one of those lands in your slow season, that is the month the overdraft happens.

Revenue does not arrive on the same schedule

The costs above are nearly flat after month four. The revenue a hire brings in is not. In the businesses I have worked with, a reasonable guess is something like 25 to 40 percent of full productivity in month one, around 70 percent by month three, and full speed somewhere between months four and six. Your trade may be quicker or much slower; a dental receptionist and a junior electrician ramp on very different clocks.

Put the two curves next to each other and the gap is widest exactly when costs are highest. That gap is the real price of hiring, and it has to be funded from cash you already hold.

The advice I disagree with: "hire when you are drowning"

You will hear that the right time to hire is when you can no longer keep up. I understand the instinct, but the numbers argue against it.

When you are drowning, you have the least spare time for training, so the ramp stretches out. You are often also short on cash, because the extra work you cannot keep up with has not been invoiced or paid yet. A hire made in that state lands on top of a thin balance at the most expensive point of the cost curve. I have watched more than one owner let a good person go in month three, convinced the hire "didn't work", when the actual problem was that the business could not carry the ramp.

A better trigger is a cash test, not an exhaustion test. Before making the offer, you should be able to set aside the first three months of total cash cost from the table, about $9,580 in this example, without touching money earmarked for tax or stock. If you cannot, the hire is not wrong, it is early. That ties back to a wider point I have made about managing growth without running out of cash: growth spends money before it earns it, and hiring is the clearest case of that.

Small details that change the plan

A few items move the numbers more than owners expect.

• Start date. Hiring in October means you pay the front loaded FUTA and SUTA for a couple of months, then pay them again from January. Hiring in late January spreads them more evenly through the first year.
• Deposit timing. Most new employers deposit federal payroll taxes monthly, by the 15th of the following month. That gives you a few weeks of float, but the money is not yours. Move it to a separate account on payday.
• Workers' comp class. Clerical work can cost well under $1 per $100 of payroll, while roofing can run many times the rate I used. Ask your insurer for the class code quote before you set the wage.
• Your own hours. If training takes 40 of your hours in month one and you normally bill $60 an hour, that is $2,400 of lost billing that never shows up on payroll.

Not every business should be hiring at all right now, and if you are unsure, it is worth reading why growing can be the wrong move before you commit.

What to do this week

Open a spreadsheet and copy the five rows of the table above, replacing my assumptions with yours: your wage, your state's SUTA rate and wage base, a real workers' comp quote, and your actual payroll fee. Then mark the two three paycheck months on next year's calendar, based on the first payday you plan to use. Add up months one through three and compare that sum to your cash balance after tax set asides. If the balance covers it, you can hire with confidence. If it does not, you now know the exact figure you need to save first. More on this kind of planning lives in the managing growth section.