What are employee costs?

Employee costs are the costs incurred as a business hires its employees.

Employee Costs: Definition, Formular & Benefits

Q: What is included in employee cost?

Employee costs may include recruiting costs, overheads and software costs, equipment costs, salary, pension, employer's national insurance contribution (NIC), expenses, and medical benefits.

Q: How to calculate employee costs?

Employee cost as a percentage of turnover is calculated by dividing employee costs by sales turnover. Employee cost % = Employee costs / Turnover x 100

Employee Costs

How exactly do we define employee costs in business terms? Each employee costs the total amount of his or her total wages. However, companies also incur other related costs, such as payroll taxes, national insurance, cost of paid time off, employee benefits, etc.

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Employee cost

Employee cost can be defined as the total costs incurred by an organisation for employing its employees. Some of the important employee cost formulas businesses may want to calculate are:

Employee costs as a percentage of turnover,
Labour productivity, and
Absenteeism.

Let's take a look at these formulas in more detail.

Employee cost formulas

Employee cost as a percentage of turnover consists of measuring the percentage of turnover needed to cover labour costs.

Employee cost as a percentage of turnover can be calculated by dividing employee costs by sales turnover and multiplying the value by 100. If the sales turnover stays the same and the employee cost increases, the overall percentage will increase. If sales turnover remains the same and employee costs fall, the overall percentage will fall.

The formula of employee costs as a percentage of turnover is the following:

$E m p l o y e e \cos t s a s a p e r c e n t a g e o f t u r n o v e r = \frac{E m p l o y e e \cos t s}{S a l e s t u r n o v e r} \times 100$

If sales turnover is £ 600,000 and employee costs are £ 100,000, employee costs as a percentage of turnover are 16.67%.

$E m p l o y e e \cos t s a s a p e r c e n t a g e o f t u r n o v e r = \frac{100, 000}{600, 000} x 100 = 16.67 %$

Examples of employee costs

Some examples of employee costs are wages, payroll taxes, and employee benefits.

Benefits of measuring labour costs as a percentage of turnover

Measuring employee costs as a percentage of turnover has two main benefits:

Know if you've hired the right number of employees
Ensure the number of workers hired doesn't eat up too much of your earnings.

Each industry has a benchmark for the rate of employee costs against sales revenues.

A benchmark is a point of reference and comparison for the organisation.

You can use this to see if your employee costs and profits are within the acceptable range. If your employee cost is too high but the profit is relatively low, you might need to consider increasing labour productivity and reducing labour costs.

On the other hand, if the rate of employee costs against turnover is too low, your staff may be underpaid or your company might be experiencing a shortage of qualified workers. In this case, you should look for ways to reduce labour turnover or attract more talents to the organization.

According to Small Business¹, the labour costs often account for 20 to 35 per cent of the gross sales. However, in some service sectors, the employee cost rate could be as high as 50 per cent.

What is included in employee costs?

Employee costs are made up of many factors. This can also depend on the type of industry. Companies need to consider all the ways in which they need to spend money on each employee. Below is the list of factors that needs to be considered when calculating employee cost.

Recruiting costs

The recruitment process could comprise of ad placement, recruitment agency fee, employee referral scheme payment, and relocation costs. In addition, the company also needs to take into consideration the time that will be spent preparing and onboarding the new employee.

Overheads and Software

Premises, overhead, software costs, and IT support need to be considered with each hire as well. This is alongside the monthly subscription to any software they need to use (depending on the type of work they are in).

Equipment

Depending on the type of job it is, this could include a computer, chair, desk and other tools.

Training

Training can take time, and this will likely cost money. Depending on the role and whether the employee is trained internally or externally, there are different factors to consider such as training on machinery, health and safety, etc.

Salary

Wages can vary based on their role, the company or even the city they work in.

Pension

The UK has a workplace pension scheme which means employers, most of the time, contribute towards employees' pension by a minimum of 3%. However, some employers choose to pay more towards this.

Employer's national insurance contribution (NIC)

It is mandatory for employers to pay NIC for each employee based on the salary each employee is paid. The rate was at 13.8% from 2019 to 2020.

Expenses

Additional expenses might include things like fuel costs, travel costs, overnight stays in hotels if the employee needs to travel for work, etc.

Medical benefits

Some companies give their staff medical/dental insurance benefits. Depending on the cover, this is likely to cost £ 400 upwards per employee.

How absenteeism affects labour productivity

Absenteeism is the percentage of employees not at work on a particular day/period.

Here's the formula for calculating absenteeism:

$A b s e n t e e i s m % = \frac{N u m b e r o f e m p l o y e e s a b s e n t}{T o t a l n u m b e r o f e m p l o y e e s} \times 100$

Labour productivity measures the output an employee produces. If a worker is absent too many days, it not only lowers her own output but also the overall output of the organization.

In addition to labour productivity, employee absence can take a toll on customer service. Imagine a secretary is absent from work without informing her manager. On that particular day, an important customer calls in but no one picks up. This could lead to a loss of customers and major sales for the company.

A high absenteeism rate is also costly for the employers as they need to hire temporary workers or ask other members of the staff to cover the work of the missing person.

Absenteeism can be used to assess employee motivation as a motivated worker will try to avoid absent days as often as she can. Unsafe working conditions or demanding bosses can result in illness and stress for the employees, causing them to take more days off.

Employee Costs - Key takeaways

Labour cost can be defined as the total costs incurred by an organisation for employing its employees. It includes their wages, payroll taxes, employee benefits, etc.
Employee cost as a percentage of turnover consists of measuring the percentage of turnover needed to cover labour costs.
Employee cost as a percentage of turnover can be calculated by dividing employee costs by sales turnover and multiplying the value by 100.
Managing employee costs is a difficult part of running a business. Figuring out employee cost as a percentage of turnover is one of the most valuable ways of understanding whether an organisation has the right number of employees and can also be used for making sure that employee costs remain at a certain percentage of sales turnover.
Most organisations have a benchmark, or an industry average, that they compare their own costs with.
Employee costs are made up of many factors. Companies need to consider all the ways in which they need to spend money on each employee.
Absenteeism is the percentage of employees not at work on a particular day/period.

Source:

1. William Adkins, 2019, "How to Calculate the Employee Labour Percentage", Small Business.

Employee Costs

StudySmarter Editorial Team

Employee cost

Employee cost formulas

Examples of employee costs

Benefits of measuring labour costs as a percentage of turnover