How much does an employee cost? Here’s how to calculate it

Hourly wages and annual salaries are only the tip of the iceberg when calculating the cost of hiring an employee. Beneath base pay lie numerous hidden expenses, from necessary employee benefits and FUTA taxes to optional overhead costs like gym memberships and cell phone allowances. Businesses must clearly understand every expense to build effective hiring strategies that preserve company profits. 

Whether you hire locally or seek out global talent, you’re probably wondering: How much does an employee cost? In this guide, we’ll break down employee expenses, explain how to calculate labor costs accurately, and offer tips to manage overhead.

Variables that impact employee cost

Before we get into the nitty-gritty of labor costs, let’s examine crucial variables that shape the total cost of hiring new employees:

Location 

Location affects baseline expenses like wages, tax liabilities, and employee benefits, whether you employ workers abroad or within your own country.

Likewise, regional differences in cost of living, job markets, and tax structures will determine what candidates consider a competitive total compensation. Employers should consider recruiting remote workers in areas with lower living costs where modest base salary expectations can offset mandatory expenses.

Role

Specialized positions that require advanced skills and experience command higher salaries, especially in tight labor markets. Some roles may require additional onboarding, job training, or certifications, further increasing labor costs. 

Market conditions

In a booming job market with low unemployment, employers may need to offer higher wages and comprehensive employee benefits packages to attract and retain new hires. Conversely, high unemployment precipitates lower wages in industries with ample available workers.

Industry

Different industries have different standards for total compensation. For example, the competitive nature of the tech and finance sectors leads to higher salary and benefit costs. Other industries, such as customer service or hospitality, might have lower average wages and fewer expected employee benefits.

Company size

Larger organizations may benefit from economies of scale. As an organization grows, bulk purchases of health insurance or automated payroll systems can be more cost-effective. Small businesses might be weighed down by high costs spread over few employees. 

Turnover rate

Every time you hire a new employee, recruitment and training expenses grow. High turnover rates also carry hidden costs. Productivity suffers during transition periods when new hires are getting up to speed, and low job satisfaction negatively impacts team morale and performance. Although fostering a healthy work culture and improving the employee experience is costly, these investments ultimately pay off in the form of a stable, productive workforce. 

Performance

Job performance and productivity are difficult to evaluate but directly affect labor costs. High-performing employees might justify higher total compensation. Underpaid employees may underperform, hindering productivity and costing more to manage, retrain, or replace. Businesses must weigh payroll expenses against the overall value generated for the company.

How to calculate the cost of an employee 

The cost of benefits, base salary, and tax liabilities vary regionally. Follow these three tips to calculate average costs for a new employee:

Determine gross pay

Begin by determining your new hire’s gross annual pay (i.e., before withholding taxes). If your employee doesn’t have a base salary, multiply their anticipated yearly hours worked by their hourly rate.

Calculate payroll taxes

You will be responsible for some of your new hire’s annual payroll taxes. Depending on your location, this might include federal and state unemployment insurance, employment training taxes, disability insurance, and Social Security and Medicare contributions.

Consider additional expenses 

Additional employment investments might include voluntary benefits, training costs, and work supplies. For collective expenses like rent, complimentary lunch, or office supplies, add up the total cost and divide by the number of employees. 

Are you looking for a streamlined way to estimate the cost of an employee in different parts of the world? Try Oyster’s free employee cost calculator.

Additional expenses to consider when calculating employee costs

An employee cost calculator is an excellent place to start, but it can’t account for every nebulous expense of recruiting employees and independent contractors. Over a single employee’s tenure at your organization, your company will pay for the following:

• Recruitment advertising
• Background screening
• Onboarding and training
• Traditional wages, overtime pay, bonuses, and commissions
• Federal employer payroll taxes 
• Federal unemployment tax
• State/regional employer payroll taxes (including unemployment tax) 
• Social Security and Medicare tax withholdings (in the U.S.)
• Required health insurance, which may include group health insurance, professional liability coverage, and more 
• Equipment or software related to the employee’s role
• Workers’ compensation insurance

Other work perks and employee benefits may include:

• Vacation time and paid time off
• Retirement plans like a 401(k)
• Profit-sharing plans and other investment options
• Voluntary benefits like health savings accounts (HSAs) and disability insurance 
• Company culture benefits (e.g., gym memberships, catered lunches, and commuting stipends)
• Remote work expenses like new technology, software updates, and internet stipends

Depending on the scope of your total compensation plan, an employee earning $50,000 per year might cost your organization $75,000 or more annually. 

How do hiring costs vary in different countries?

There’s no one-size-fits-all budgeting model for a distributed, global team. Many assume they can save by hiring in developing nations, but lower salaries don’t always translate into labor cost savings. 

Budgeting begins at the recruitment phase. Here are a few crucial considerations when hiring international workers:

• A local attorney to help you with contract law or insurance issues
• Bilingual staff to assist with interpretations and interviews
• A qualified professional well-versed in local state and federal insurance, payroll taxes, and health insurance
• A comprehensive understanding of local employee compensation expectations, including hourly rates, base salary, and benefits packages 
• A clear grasp of local work culture, including hours worked and voluntary benefit expectations

Rules and regulations vary from country to country, so careful research and flexibility are required before taking on a new hire. To get started, check out Oyster’s guides to global hiring costs. Our employment cost index provides a fast and simple way to compare employment costs in different countries.

How to reduce employee costs

With creativity and flexibility, you can reduce overhead costs for employees. Here are four strategies to consider:

1. Offer remote work options

A physical office space drives up overhead costs such as rent, utilities, and equipment. Companies can save by allowing employees to sign in from home.

Remote work also offers flexibility that can attract and retain talent. New hires may accept lower annual salaries or base pay for a more flexible schedule. Likewise, you may be able to attract employees who live in areas with a low cost of living and have lower expectations for salaries or hourly rates.

2. Build a distributed workforce

A distributed workforce allows you to strategically hire employees from areas with lower labor costs. Organizations can develop hiring practices that leverage talent across numerous geographic regions, reducing wage expenses without sacrificing specialized skills. Hiring managers should carefully consider logistical challenges—time differences, communication challenges, and cultural distinctions—to build effective teams. 

3. Streamline payroll 

Some administrative tasks can be automated, freeing up time and resources. Automated payroll systems or third-party administrative providers minimize errors, reduce staff, and eliminate the need for extensive manual oversight. Additionally, airtight systems that review and audit payroll practices help ensure compliance and identify cost-saving opportunities. 

4. Hire independent contractors

Contract workers can be a cost-effective alternative to full-time employees. They provide their own tools and training and take responsibility for tax liabilities, which can translate to cost savings in administrative work and company resources. However, contractors have potential downsides, like limited control of their work schedules and the risk that they may end their services unexpectedly.

Optimize costs and reduce risks with Oyster

Accurate employee cost calculation is more than good budgeting. It ensures that your organization complies with local tax and labor laws. With Oyster’s EOR services, you can hire, onboard, and pay compliantly in 180+ countries. We’ll handle the nitty-gritty so you can focus on finding the best global talent for your team.

Disclaimer: This blog and all information are provided for general informational purposes only. They do not, and are not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter before acting (or refraining from acting) based on any information provided on this website.

About Oyster‍

Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.

Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.