Mathematics of Hiring

At what point does it make sense to hire someone for your business?

How much should you pay your new employee?

These are questions that are asked on both sides of the table – the business owner expanding the size of their business, and on the side of the prospective employee, trying to get paid their fair share.

First, in order to hire someone, your business must be able to afford that employee. While this sounds simple, the reality is that often a business will need to hire someone but cannot afford to do so – the payment for the new employee has not yet been received.

As an example, John owns a lawn care business. He accepts 10 new customers, but does not have the time to do all the work for them. Because he is only paid after doing the work, the cash to pay another employee is not yet available, but without the new employee, he may not be able to earn the money from the additional contracts.

The solution, in John’s case, might be to take out a short-term loan, or make use of an operating line of credit at his bank. The mathematics of borrowing money will be explained in a moment, once we discuss the second part of the equation.

An employee is not worth the amount of work they do. For example, a lawyer might be billing at $300 per hour, but that does not mean the lawyer is earning $600,000 per year. Even if the lawyer managed to bill 2000 hours in a year, they would not be paid that amount. He might earn about a third of that, or $200,000 based on those numbers. He might earn even less.

The reasoning for this is simple. The company does not need to bring along another employee who exactly earns his keep. An employee who costs $50,000 and only does $50,000 worth of work is not worth keeping around. They do not bring value to the company. While there are times when such an expensive employee is justified, those times are few and far between.

In order to be worth hiring, an employee must therefore do more work than they are being paid for – their billings must out-weigh their cost. So an employee earning $50,000 has to do work that can be billed outside the company for more than that. One of the common multiples is 3, so that employee would have to do $150,000 worth of work.

Getting back to John’s case, the reason he’ll be able to borrow money to cover the cost of hiring an employee is because that employee will be doing more work than they’re being paid. If they bring in twice their salary, then the cost of borrowing their salary (that is, the interest on the loan) is offset by the additional income they bring in.

The problem, of course, is that many employees don’t see this side of the equation. They see themselves working on projects where their work is being billed at $50 per hour, or $75 per hour, and yet they’re earning only $45,000 or $50,000 per year. Since they know their value to the company, they don’t understand why they aren’t being paid more.

However, there is, of course, additional costs to having an employee. Some companies will regularly provide their employees with their adjusted salary – factoring in all benefits, the rent on the space they occupy, the equipment they use, the software licenses they require, the food and drinks available. Once all these costs are added in, the employees will usually see that they are earning significantly more of their billings. The employee doing $200,000 worth of work might actually be costing the company $125,000 or more once these items are considered.

Secondly, the company can also create a profit-sharing system based on billable hours and the rates for those hours. An employee who manages to generate 2000 billable hours in a year at $50 per hour would get a bonus relative to the fact that they managed to generate $100,000 in revenue for the company.

The amount of the bonus? That would depend on how much money is actually available at the end of the year, and how the various employees performed in relation to each other and in relation to their function.