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Financing New Employees: Can I Afford to Hire?
Your workforce is your most valuable asset as a business owner. When is the right time to hire a new employee, though? Here’s what you need to know about calculating the financial details of new hires.
Many business owners in Australia find it difficult to plan the process of hiring new staff. You need to know about financing new employees. Determining whether or not it’s the right time to hire a new staff member can be a complicated process, but there are many situations in which new hires are critical to the success of a key growth stage.
Small businesses that are experiencing growth or are attempting to scale must often weigh the potential benefits of new hires against financial constraints. In most cases, Australian small businesses operate with a limited amount of capital that can be directed toward growth or hiring new staff.
When is the right time to hire a new staff member, and how can you make sure your business is ready for the costs associated with new employees?
Do Your Forecasted Sales Cover Salary Costs?
If you’re a small business owner, it’s important to consider employees as potential assets. While it’s not possible to account for employees as assets on your balance sheet or through cloud accounting software such as Xero, employees represent a function of your business that adds financial value.
While employees possess the potential to add dramatic value to your business, they require time to become cost-efficient. Unlike machines, which can be purchased and begin operating instantly, employees are people — it’s necessary to ensure that they are comfortable and capable in their new role.
The time involved in training and acclimatising new employees into your business culture represents a cost in sources and energy, which can place significant financial constraints on your business. The time and energy invested in a new hire could potentially be invested in generating new revenue.
If handled incorrectly, the process of hiring new employees can inhibit and even hard revenue growth, which can directly affect profit. In the worst case scenario, poorly handled hiring or an inefficient hiring strategy can create losses.
How Much is Enough?
It’s critical to ensure that your business possesses enough revenue to cover both the cost of a new employee and the indirect costs associated with training and establishing a new employee within your business.
How much revenue is enough, though? It’s important to set aside a minimum of at least two times the monthly salary cost of a new hire before engaging new staff. This should be calculated based on new, confirmed and secured revenue within the same month the new employee is hired.
Following this practice ensures that your business possesses enough capital to cover any potential costs and more.
A business considering hiring a new employee with a monthly salary of $5,000, for example, should ensure that they have confirmed at least $10,000 in new sales or revenue before signing any new employment contract with the potential employee.
New Employee Costs Versus Profit
The potential impact of financing new employees with insufficient revenue could potentially erode any profit that the new hires may generate.
In simple terms, the costs incurred by hiring new employees or staff may exceed the revenue generated by the new employee. If this situation continues on an onion basis, it’s possible that your business may begin to lose profitability.
More employees doesn’t always mean more profit. Ensuring that your business possesses a minimum of two times the employment cost of a new employee will ensure that your business remains profitable during the growth process, scaling revenue, headcount, and profit simultaneously.
Are You Generating Enough Revenue?
Revenue is not the only benchmark you can use to determine whether your business is ready to finance new employees. If your business generates sufficient revenue, it’s also important to consider how busy your business is.
It’s important to clearly differentiate between business and productivity when gauging the overall workload of your business. A business, for example, may be delivering products or services in an inefficient manner, or operating in a time-inefficient manner due to significant administrative friction.
Inefficiency in a business may create more work, but inefficiency isn’t solved by hiring new staff. Adding personnel to an inefficient operational system will create headaches, increase costs, and decrease profits.
If you’re ready to hire new staff for your business and your business is unable to generate sufficient revenue, then it’s highly likely that your business isn’t ready for a new employee. New employees should emerge from higher revenue — not the inverse.
Hiring new employees before your business is ready could potentially magnify the issues that are preventing your business from generating more revenue. Before you’re ready to hire new employees, it’s worth calculating your business revenue on a per-employee metric.
Always Have at Least 2 Months of Wages Ready
A key issue faced by businesses operating complex payrolls is the obstacle presented by late remittance by customers and clients. Cash flow issues may cause financial situations in which sufficient capital to cover payroll is not available when it’s time to remit.
To protect your business from encountering this situation, establishing a two-month salary rule will ensure that your business is able to sustain a 60-day receivables time frame. It’s best to adopt the mindset that your new hire will be unlikely to generate sufficient revenue and cash flow from the first day on the job — establishing a revenue buffer will protect both yourself and your employees.
Business growth can catalyse a rapid growth mindset, causing business owners to get caught up in the adrenaline rush of expansion and scaling. Before hiring new employees, however, it’s important to carefully assess the financial situation of your business and accurately assess whether your business is financially prepared to cover the cost of new employee payroll. You can also look at Government incentives but be careful as they only provide short term help.
If you’re not sure whether your business can finance new employees or whether new employees will enhance the profitability of your business, reach out to Fullstack for cashflow forecasting guidance today.
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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech companies, agencies and entrepreneurs.