The only reason to employ people in your business is if you can make more profit by doing so than doing everything yourself or outsourcing. And the only people you should employ are profitable ones.

That said, how do you know which of your employees are profitable? Unfortunately you don’t unless you know how much they cost, and I mean really cost. You see most businesses only calculate a proportion of the cost of employing someone. It goes something like: wages + benefits + employer’s national insurance + overheads. Some neglect overheads, but then employees take up space, require heat and light, drink tea and use stationery and the bathroom so you need to take into account space, utilities and supplies.

So an employee paid £10 per hour, plus a Christmas party, bonus and national insurance may actually cost, say £12 per hour. If it costs £2,400 per month for overheads and you employ 4 people, that is £600 each, divided by 150 work hours is £4 per hour, so we are already up to £16 per hour.

But there is more. The real cost of employing people includes three more elements which hardly any businesses take in to account.

The first is rework and the cost of mistakes. Even if you have great, documented systems which specify exactly how a job should be done (and most businesses don’t) your employees will make defective goods, ship them to the wrong place, pack them poorly, waste materials, not answer the ‘phone, fail to follow up leads and a host of other mistakes that cost you business and money. And 100% is your cost. The amount obviously varies by business and employee but conservatively will be at least £300 – £400 per week per employee, so that’s another £10 per hour making £26 per hour.

Next is the cost of absenteeism and its partner presenteeism (being present but not actually making you money). Absenteeism is easy to calculate: it is holidays, personal and sick leave, training days and so on. Presenteeism is harder to calculate but it is there just the same. It is the time spent on personal ‘phone calls and emails, surfing the internet, researching holiday destinations, chatting to colleagues, reading a book or magazine or just doing nothing. And left unsupervised this time can be significant. If only a third of the time you pay for is wasted (and some studies suggest it is far more than that) then that means your hourly cost will increase to £39 per hour.

The last element of employee cost that is often overlooked is your time. In big businesses this cost is easy to calculate because it’s the cost of HR departments and middle managers, but in most small businesses it is your time. You are leader, manager and supervisor, you have to recruit, train, appraise and sometimes fire. Let’s assume your time is worth £100 per hour and each employee takes up 2 hours of your time per week, that’s another £5 per hour making a total of £44 per hour. Did you realise that was how much you were paying your staff?

The final calculation you need to do is to work out how much profit your employees need to make to make that investment worthwhile. In other words what is their return on investment? At £44 per hour, that is £6,500 per month or £79,000 a year per employee! What level of profit do you need to justify that amount of investment?

The cost of employing people is often the single biggest, and least understood, cost in most small businesses and is often ‘hidden’ because the accounts only show the wages + benefits + employer’s national insurance element. If you really want to understand your business numbers, and use them to drive strategies such as outsourcing, then you need to understand the real cost of employing your staff.