Accounting - Purchasing/Cost Control
Payroll and the Cost of Labor

Payroll and the Cost of Labor

The Administration of Your Payroll

The two key elements in establishing an effective payroll administration system are, first, setting company policy regarding pay and, second, determining how often payroll will be done and who will do it. These are the decisions made by the business owner, and they should be well thought out not just made on the run.

Establishing Payroll Policy
Unless you are utilizing union labor and subject to a negotiated contract, the parameters (within the law) of payroll are yours to set. You will likely negotiate vacation time with new employees and ultimately set a companywide standard such as one week after the first year, two weeks after year three, and three weeks after year five. It is best to be conservative going in; you can always loosen the policy, but it is almost impossible to take time back once it has been given. The same goes for paid holidays such as Thanksgiving, Christmas, and so on. Decide how many you can afford and be conservative. The day after Thanksgiving is appreciated because it makes a four-day weekend, but it is not necessary. The last portion of these “time off days” are sick time and personal leave. Find out what is typical in your type of business; you want to be competitive to attract the right people, but again be cautious in the beginning.

Consider this: If you give two weeks vacation, five holidays, and five sick or personal days, that is a total of 20 days. The work year is 260 days long, and that means that almost 8 percent of your labor costs is being paid for nonproductive time. As we go along and look at other benefits, you will see how expensive employees are—far beyond the wages you think you are paying. Remember this when setting budgets. The average “extra” cost of each employee is 35 percent, so a $40,000-a-year person is actually a $54,000-a-year person.

Getting the Payroll Processed
If you have a small number of employees and a good computer system, you can do your payroll processing in-house. But as your numbers grow and the type of information you want gets more complicated, sending this task out to an outside service makes far more sense.

Make sure that the person who tracks and transmits your payroll keeps accurate records; the use of a time clock is one good way to be sure all hours worked are correctly maintained. Vacation days as well as paid time off should be scrutinized to be fair to both employer and employee.

Benefits Can Be Costly: Keep to a Budget
Without adding anything additional, your payroll is increased by approximately 24 percent by the cost of vacations, FICA (Social Security) contribution, unemployment insurance, and statutory workers’ compensation insurance. But that does not end many benefit packages that may also include health (including dental) insurance as well as life insurance plus perks such as car expense, which may be required in certain circumstances. This can add up in a hurry and, if not controlled, may make the company unprofitable or uncompetitive.

Again, be cautious at the outset because adding benefits is far easier than trying to reduce them. Full health coverage for a family can easily cost $600 per month, or $7,200 per year. For an employee earning $40,000 per year, this is an 18 percent add-on and would increase the benefits to a total of 42 percent (24 percent established by vacation, tax, and other insurance), making the cost closer to $60,000. This is a fairly high place to start unless you are working in a competitive situation for specific skills or talents.

The issue of company cars as a benefit is a difficult one as well. The total cost can be substantial and remains fixed regardless of the productivity of your employees, normally sales personnel, because the cost isn’t tied to any set level of sales. Why not start with a reimbursement plan (mileage and perhaps a gas card), and if the cost seems to be justified, you can consider the car as well; just remember that insurance will also be a cost, as will maintenance, parking, and all other incidentals.

For many companies, payroll for both direct and indirect labor is the largest line item. Remember that there are costs beyond the pay itself, and keep them in line by creating and sticking to a budget.

Payroll Taxes
Keep in mind that you must budget for those taxes that are add-ons to your payroll. First is the federal FICA tax, which is for Social Security and Medicare. You will also pay a tax to the Internal Revenue Service as well as your state for a contribution to the unemployment fund. The percentage on the FICA tax is fixed at 7.8 percent but the unemployment tax is variable depending on the status of your account. The more people who collect, the higher the fee. Know how much and when these payments are due and take great care that you have set aside the money to pay them.

It is a serious mistake not to pay your taxes on a timely basis. The late fees for not filing and not paying can be enormous and add up to a 50 percent penalty to the taxes you owe. Once this unbudgeted and unaccounted cost is added to a company’s expenses, profits go out the window and cash flow is strangled. And trying to avoid payments won’t work because the taxing bodies have strong powers of enforcement behind them. This is a situation to avoid at all costs.