Surprise!! Hidden Labor Costs Hiding In Plain Sight

November 11, 2019

Hidden Labor Costs Hiding In Plain Sight

 

Why is it so hard to run a profitable small business and build wealth?

Here’s another fun topic. Let’s talk about another hidden expense that only affects the owners of small business. Let’s start with a small math problem illustrating the chasm between the amount of money that is costs to employ a person and the amount of money they actually feel they are being paid.

Let’s just say that you have an employee who you would like to bring on board and pay a salary of 30,000. Let’s also assume you would like to provide benefits to this employee including healthcare and a very basic 401K

Your brand new person is happy with their offer and excited to get to work. A couple of weeks later, it’s payday….. so 30,000/24 payrolls per year is 1,250. Pretty simple right? Not so fast.

In addition to the employees 1,250, the employer is required to withhold a series of taxes on behalf of the employee. The largest pieces of this are related to federal and state income tax and social security..

Let’s just ballpark some figures. 

Federal income tax is going to average 20%. State income tax varies from state to state. Pennsylvania is slightly above 3%. Local tax is 1% minimum. Social Security is between 6%-7%. That’s 30%!!

1,250 becomes 875…..magic! I bet you didn’t realize that taxes were magic….but they just made 30% of your paycheck vanish. That’s a pretty amazing trick. 

As business owners we are empathetic towards the plight of your employees. However, we’ve also got problems of our own and 99% of our employees are either completely in the dark about them or absolutely don’t care because we have all the money right?

Let’s take a quick snapshot of employer expenses. What else is ADDED to the 1,250 per check we’ve committed in payroll?

What else do we get to pay? Let me count the ways.

  • Employer side of social security and Medicare 9.1%
  • Workers compensation insurance – while this is not directly a payroll tax, it’s a necessary expense that is directly related to payroll.
  • Additional contributions to health care
  • Additional contributions to retirement plans
  • Unemployment Contributions

Speaking from personal experience, the total of all of these additional costs represent about 11-15% in additional expense. This essentially means that a 1,250 payroll costs the owner another 150 – 180 in additional costs. This doesn’t seem like a lot until you do the math. 150 -180 per payroll with a staff of 15 people at 30,000 per year in payroll turns into 54,000 per year!!

Over a 10 year period, ownership contributes 500,000 for taxes and payroll expenses that produce ZERO additional profit. In fact, based on my experience, I’d argue that it doesn’t even create goodwill with your employees as 99% of them don’t comprehend it or care.

I will back this statement up with a true story. The federal tax cut that was enacted recently effected normal federal income tax deductions across the country. Tons of employees across the country were dumbfounded to learn that they OWED taxes instead of receiving a refund as they had become accustomed. The simple reason for this was that payroll companies didn't deduct as much as in the past. Simply said, the employee received more or all of their money instead of it being held. Their tax bill actually ended up being lower than it had been in years past but because they OWED it, they felt that taxes must have gone up. On some level, they felt that their taxes ate up their entire refund AND then they owed more.

If they aren't paying attention to their own paycheck, employees are definitely not worried about yours.

Calculating how 1,000,000 went missing

If we assume that you could earn 10% with your money per year through debt reduction or putting those funds to use to grow your business, the math tells us that 1,000,000 dollars in cash and business growth is pulled out of your business through these employment expenses in 10 years!!

Take just a minute and read that last paragraph out loud. We just mapped out a very simple road map to ONE MILLION DOLLARS that you as the owner no longer have at your disposal. And remember...this example is built on a very small business that is composed of 15 employees who each make about 30,000 per year. This means that you have to make 2 million dollars just to keep 1 of them.

Who is the richest person you personally know? I'm going to venture a guess that 90% of those of you reading this blog would say the richest person you know is worth...about a million dollars. Wrap your head around that one for a minute. You as the owner in this example went from being the wealthiest person you know to.....NOT being the wealthiest person you know.

AND

You are the one who has taken all of the risk and put in all of the long hours on your business while everybody else did their 9-5, collected their check and complained about their boss. Meanwhile, their boss is probably trying to figure out where his 1,000,000 went too! 

Embrace the horror

So...we hire a staff of 15 people at 30,000 per year.

They aren't happy because about 9,000 of their 30,000 (30%) is withheld for taxes and blame their employer for not paying them more. In fact, I'd venture to guess that many of them feel they were lied to. They remember their boss promising 30,000 but since they don't get 30,000, it may seem the boss is to blame.

We as the owner are down about 54,000 per year in employer taxes which equates to about 1,000,000 in business value being siphoned out of our business over a 10 year period as we computed above.

Did anybody else just throw up a little bit in their mouth?


The sheer amount of revenue/profit inertia that it takes to escape the crushing gravitational pull of this black hole blows my mind to this day.

There is very little we as employers can do about social security or Medicare expense. I you are small enough, you do have to ability to make decisions based on healthcare or 401K expenses. You can choose to spend the money or you can choose to not spend the money and then risk losing the employee to competitors who have decided to commit the dollars.

What can you do?

Since there is little that you can do to reduce these added payroll expenses but you should at least feel like you are purchasing something with your money.

Construct hiring appropriate hiring documents that don’t simply list a salary of X. Make sure your offer letters list ALL of the benefits of working for you.

Make sure to include Salary + Social Security and Medicare contributions + Unemployment contributions + Healthcare/401K and any other benefits that illustrate how much you are putting into this employee.

Start off on the right foot with them. Be very up front and honest about what you are contributing to them and what you expect in return and hold them to it.

Understanding all of the costs of employed labor is crucial to you building a model that keeps your profit margins healthy. Remember, if the mother ship isn’t healthy, nobody is safe. You always put your own oxygen mask on before helping others.


So that was a really fun blog. If you are feeling stuck, and looking for a boost, I'd love to hear from you. Things DONT have to be this way. They can be better but hope and prayer are not a viable strategy. I've set aside time in my schedule over the next couple of weeks. Just click the link below and book your complimentary strategy session.

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