Friday, January 11th, 2019
One of the most common questions I hear from clients, friends and fellow small business owners alike is, “How much does it cost to pay my employees?”.
Unfortunately, to really answer that question in a clear and accurate manner, there a few key concepts you need to understand first.
There are two different categories of costs associated with processing payroll for a small business; there are costs that are constant and there are costs that are variable. Once you have determined your constant and variable costs, then figuring out the true cost of paying your small business’s employees becomes a simple equation.
Constant costs, in the context of this explanation, are expenses that are simply unavoidable. No matter what you do to try to reduce the expenses associated with your payroll, constant costs will always be there. There are 3 distinct constant costs involved when calculating payroll expenditures for a small business.
The first cost is the price of the labor itself. In other words, how much do you pay in employee wages each pay period? Naturally, for many small businesses there will be employees that have a labor cost that fluctuates pay period to pay period. Common examples are part-time employee who have schedules that change frequently, and any full-time employees that are paid hourly, but may work either slightly more or less than the standard 40 hours on any given week.
Regardless of the fact that this cost may fluctuate, it is still considered a constant cost because you will always have to pay your workforce for their labor. Calculate an average weekly wage for all of your employees, individually, add them all together and the result is the first constant cost of payroll your business must pay for, salary.
Generally accredited to Benjamin Franklin, who, in 1789 wrote in a letter, “In this world nothing can be said to be certain, except death and taxes”, this popular turn of phrase is likely one that you all have heard before. Your small business’s payroll certainly is no exception to Mr. Franklin’s old adage. This is an expense that will always exist in one form or another; thusly, we have identified the second constant cost of processing payroll for your small business, taxes.
When you sit down to do your company’s payroll, you are more than likely utilizing the services of two or more 3rd parties to accomplish the necessary tasks. The software programs used to input the payroll information into to your small business’s financial records definitely make life easier, but they also charge your licensing fee. Additionally, there are payroll service companies (EX: ADP) that handle the transferring of money between accounts, print checks, generate W-2s, etc. Those services are also not free either. A basic payroll service will charge your business per check that it is distributed, will collect a base account fee and charges for additional services like direct deposit and tax filing.
All the aforementioned expenses, in addition to accounting software subscriptions, are just simply the cost of doing business. As a business owner these tools and services are not optional; those expenses constitute the 3rd constant cost of involved in the processing of payroll, fees.
Variable costs are a bit more tricky. For the purpose of this blog think of a variable cost as a cost that every individual person out there would put their own price-tag on. It’s variable because it is not quantifiable in the strictly mathematical sense. With regards to you, as a small business owner that sits down at their desk and processes their own company’s payroll every pay period, you are likely receiving some sort of basic salary each month, in addition to any profits the company may produce. The cost of that salary is already factored into the equation under the constant cost of what you determined your company’s expense was for salary.
The variable cost you need to think about is what is known as an opportunity cost, and it is strictly determined on an individual basis and for one’s self. To determine the opportunity cost you have to ask yourself some serious questions and really reflect on your answers. Consider the following.:
Now, expand a little more and start thinking outside of the world of your business:
Think about your answers carefully. Consider the answers of those that can be numerically quantified and those that can’t. Based on your answers, you need to determine the value of the final element to the equation, (missed) opportunity cost.
With the equation complete you can quantify all aspects of the constant costs and come up with a numerical total. Take that number and add it to both the quantifiable and unquantifiable aspects of your opportunity cost analysis alikem and you have the true cost of payroll.
Now answer one final question…Does the True Cost of Payroll come out to be a justifiable (+ / -) expense to both the company and its most important asset, you?