What’s the total cost of an employee?


What’s the total cost of an employee?

It’s obvious that the cost of employing someone is more than just their wages or salary, but what does it add up to when every employee-related cost is included? This article discusses all the possible cost items and provides guidance on how and when to calculate them.


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It’s obvious that the cost of employing someone is more than just their wages or salary, but what does it add up to when every employee-related cost is included? This article discusses all the possible cost items and provides guidance on how and when to calculate them.
Basically, the total cost is the total of all the direct and indirect costs that can be attributed to employees.
Direct costs
Direct costs are easy to calculate. Basically, they are the employee’s base wages or salary, plus all cash payments on top of that. These payments may include:
  • overtime and other penalty rates
  • shift loadings
  • cash allowances
  • bonuses and commissions
  • leave payments, eg sick leave or annual leave — note that a loading may be payable on annual leave payments
  • any other form of cash payment.
Indirect costs
There are two categories of indirect costs:
  • cost of items that provide a benefit to the individual employee
  • cost of items that are a part of running a business and a consequence of having employees.
'Benefits' covers a very wide range. Common ones include cars, loans, travel, free or discounted products and services, parking, insurance, health insurance payment or contributions, mobile phones, laptops/other computers, education expenses, shares, membership of professional organisations, and accommodation. Superannuation is also a benefit, but is discussed separately below.
You need to calculate both the cost of providing the benefit to the employee and the value of the benefit to the employee. For example, when a company car is provided, private use of the car will be a benefit to the employee, but when it is used for work purposes that will be an operating cost for the employer. When calculating employment costs for each employee, you need to add the Fringe Benefits Tax that applies to the benefit to the value of the benefit to the employee.
Fringe Benefits Tax is a complex issue. Various formulae are used to calculate its values for different benefits, and some benefits are exempt from FBT, mainly ones of low value. Further information about FBT is available from the WorkplaceInfo Fringe benefits webpage.
The value of superannuation contributions should also be counted as an indirect cost because they are paid directly to a fund rather than as cash to the employee. Superannuation contributions are compulsory, and if they are not paid the employer must pay the Superannuation Guarantee charge. The SG charge should be added to indirect costs as well.
Other costs
Finally, there are costs that employers must pay in regard to having employees at the workplace. The most common of these are workers compensation premiums and payroll tax. Workers compensation premiums vary quite widely according to the industry and type of employment, as well as the employer’s past history. Payroll tax is a state tax and typically does not apply to small businesses, but the rates vary from state to state. Therefore, it is not possible to quote 'standard' rates for either of these costs.
Sorting out the terminology
There are a number of terms used by remuneration specialists to describe various calculation methods. The following are the main calculation methods:
  • Base salary and wages: simply the standard rate payable to employees without any 'extras'. For ease of calculation, it is usually expressed as an annual amount.
  • Total Remuneration: base salary and wages plus the other direct costs (overtime, allowances, leave loading, etc) and the value to the employee of fringe benefits.
  • Total Employment Cost: Total Remuneration plus FBT payable on the benefits. Also referred to as Total Remuneration Package, and widely used in remuneration benchmarking surveys.
  • Total Employee Reward: Total Employment Cost plus other short-term incentive and bonus payments.
  • Total Target Reward: Total Employment Cost plus longer-term (at least annual) incentive and bonus payments.
Note: none of the above definitions includes items such as workers compensation premiums, payroll tax or SG charge payments, so none can really be described as measuring the full cost of having employees.
Another frequently-used term is 'on-costs'. This divides employment costs into two components:
  1. base salary and wages, plus
  2. on-costs, which basically refers to everything else.
When studying data in remuneration surveys, it is important to be aware exactly which calculation method the survey has used, then use the same method if you want to benchmark your own results against the data.
Calculating the total cost
If you wish to calculate the total cost of employing an employee, add all the following items together:
  • base salary and wages
  • other direct cash payments such as penalty rates, leave loading, allowances, etc, but don’t double count basic leave payments — these are simply payment of normal salary/wages that would be made in any case, whether the employee is at work or not
  • cash value of employee benefits provided to the employee, including superannuation contributions
  • FBT payable on these benefits
  • value of any incentive and bonus payments
  • workers compensation premium (per employee)
  • payroll tax (per employee)
  • SG charge, where payable
  • other miscellaneous costs such as cost of training courses.
It is not normal practice to include the cost of items such as the provision of uniforms for employees to wear, office equipment, etc, because these items are regarded as tax deductible business expenses.
It might be possible to argue that personal use of emails, internet access, etc, by employees at work is an 'employment cost', but reality is that these would be impracticable to measure accurately (and potentially unlawful unless certain precautions are observed first). However, an employer determined to cover every possibility could make an estimate of the percentage of 'downtime' employees spend at work and convert that to a monetary value.
No typical ratio of direct costs to on-costs
Using the components above and converting all costs to an annual figure, it is possible to calculate the direct costs and on-costs for your own organisation. Over time, you can monitor trends in both types of costs.
Some employers are keen to discover how their calculations compare with other businesses. While surveys of on-costs and total employment costs were published in the 1980s and 1990s, these had problems and have been discontinued.
The Australian Bureau of Statistics used to publish surveys of employee benefits incidence and costs, but there is no such recent data on its website. A Catalogue titled 'Employee Earnings, Benefits and Trade Union Membership' (Catalogue 6310.0) was last published in April 2008, reporting a survey conducted in August 2007, but its references to benefits are mainly confined to superannuation and forms of leave.
The findings of overseas surveys should be treated with great caution. For example, US employers, generally, pay health insurance premiums on behalf of their employees, and taxation and other legislative regimes are completely different to Australia. Read the definitions very carefully if studying overseas data.
The best source of current information is probably the various commercially available remuneration surveys such as the annual Australian Institute of Management National Salary Survey. While these survey reports are not cheap (they are available at discounts to employers who take part in them, and AIM offers a further discount to its own members), they do provide detailed information.
Estimated on-costs
For what it’s worth, past surveys often estimated on-costs to be around 35-40% of direct costs. But treat this figure with great caution — here are just a few of the possible variables:
  • The percentage will be higher than average if there are many executive/professional employees. They are usually on salary packaging arrangements and receive extra benefits.
  • The percentage will be higher than average if the business has high workers compensation premiums due to a poor past safety record, or because it operates in a high-risk industry or has few office employees.
  • Costs such as workers compensation and payroll tax vary from state to state.
Therefore, if you are going to compare your organisation with others, make sure you use the same calculation methods in order to compare apples with apples.
A cautionary note
It’s not clever to keep referring to employees as 'labour costs' — they are people. By all means, calculate employment costs and communicate the results to them. But remember, employees are assets, not financial liabilities, if you want to encourage engagement, commitment and retention.
Source: Mike Toten, HR writer.
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