The Cost of Hiring an Employee: Explanation and Formula

For most businesses, their biggest expense is staffing. And the costs go beyond salary to include a variety of taxes and benefits such as   health insurance, annual leave, and training.

The costs don’t end there. Hiring workers involves significant expense as well. If you’re a manager looking to expand your team, you know cash flow is often a constraint, especially for small businesses. Understanding the expenses involved in the hiring process can help you lower your average cost of hiring.  

Once you start to recognize the various concealed costs your business undertakes during hiring, minimizing them is simpler. For instance, advertising the job opening, a cost that’s often overlooked, can be expensive. This can be curtailed by developing an employee referral program that brings job candidates without advertising.    

Research by the Society for Human Resource Management (SHRM) pinpoints the average cost of hiring a new full-time employee at nearly $4,700. However, keep in mind that this figure represents the national average. The actual cost-per-hire can vary depending on company size, hiring volume, and seniority of the positions being filled.  

This article breaks down the expenses involved in hiring an employee and explains how to calculate it.

• Breaking down the average cost
• Formula: How to calculate the cost of hiring
• The cost of different types of employees
• Recruiting and hiring costs
• Training costs
• How much do benefits cost per employee?
• Best practices when hiring employees and lowering hiring costs

Breaking down the average cost

Knowing your average cost of hiring can help you plan ahead and allocate resources. It’s an important metric that enables you to make better informed recruiting decisions.

To break it down, you should look at the recruitment process. Beyond the employee’s wages, hiring includes several costs.

• Recruiting and hiring: All costs incurred from advertising to interviewing and screening candidates are included here.  

• Training: The expenditure on training programs and employee support is factored into the training cost of a new hire.

• Benefits and insurance: Various overheads calculated after the base salary, like the FICA, FUTA, or state unemployment tax, are added to the cost of hiring.  

• Miscellaneous overheads: Expenses specific to a role, such as uniforms, travel allowances, or other services engaged for new employees, feature in miscellaneous costs.

Apart from these, onboarding a new employee results in certain fixed expenses, regardless of industry.

• FICA: The Federal Insurance Contributions Act (FICA) is a federal payroll tax paid by both the employer and employee. FICA helps fund Medicare and Social Security programs.

• FUTA: The Federal Unemployment Tax Act (FUTA) is a payroll tax paid by employers on their employees’ wages. The revenue from the FUTA funds unemployment benefits.

• SUTA: State unemployment tax (SUTA) is tax paid to the state where the work takes place. Paying SUTA can reduce the burden of paying FUTA taxes. Since this varies from state to state, you should check with your state department to know more.

Another decision that affects the average cost of hiring is choosing between full-time and part-time roles. State mandates like taxes and benefits differ according to type of employment, which can impact how much an employee costs your company.

Considering the resource-intensive nature of the recruitment process, you’ll want to monitor the expenses and optimize your average cost of hiring. The first step in doing this is by calculating your average cost of hiring.

Formula: How to calculate the cost of hiring

Cost per hire is a simple metric that factors in all of the expenses from the various stages of the hiring process. You can calculate your company’s cost per hire by using this simple formula:

Cost per hire = (Internal recruiting costs + External recruiting costs) / Total number of hires

Internal costs

Simply put, internal costs are the money spent within your company during the recruitment process.

Internal costs include:

• Salaries for the human resources (HR) team
• Fixed costs, such as physical infrastructure (e.g., office rental)
• Hardware (computers, company phones, etc.)
• Software (various services used by team members, e.g., Microsoft Office)
• Employee referral incentives (if applicable)

External costs

External costs are defined as expenses related to external vendors during the course of recruiting.

External costs include:

• Advertising and marketing (job boards, social media ads, etc.)
• Recruiting events (e.g., career fairs, campus recruiting events)
• Background checks
• Drug testing
• Assessments (e.g., job trials)

The cost of different types of employees and workers

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Full-time workers often prove more expensive than part-time or independent professionals. This is a result of the benefits and overheads bundled with the full-time individual’s final salary. Hiring a part-time, on-demand, or freelance worker might be a more attractive choice for small business owners who wish to reduce costs.

To break it down, we look at different types of workers and the overheads attached to them.

• Full-time employee: An employer pays the base salary and covers benefits like health insurance, vacation days, paid sick leave, retirement, and bonuses.
• Part-time employee: Part-time workers typically don’t receive paid time off or health insurance, and are generally excluded from participating in retirement plans.
• Temporary worker: A temp worker is entitled to workers’ compensation and overtime pay but is usually excluded from benefits and insurance.
• Freelancer: Freelancers are often the most cost-effective, as you don’t incur any of the expenses reserved for full-time and part-time employees. Freelancers are often classified as self-employed, so they are responsible for paying self-employment and income taxes

While deciding which type of role to recruit, consider your ability and willingness to absorb labor into your business. Another factor that can guide this decision is the industry you’re in and the type of resources you require.

Recruiting and hiring costs

Expenses associated with hiring include the salaries of your recruitment team, marketing expenses, and payments made for background checks.

To source a new employee with benefits, the company will incur a cost up to 40% of an employee’s base salary. If you’re recruiting with an internal team, you’ll also need to consider the cost of advertising your vacancy. These can vary significantly depending on where you choose to market the role.

Once you have a talent pool, your team will start to screen and interview individuals. While screening candidates, a background check may cost between $10 and $500, depending on how extensive you want the inspection to be. The more in-depth checks will cover:

• Employment history
• Education verification
• Drug testing
• Eligibility to work
• Visa status
• Criminal history

As mentioned, it may cost a company around $4,000 to find and hire a new employee. The cost increases proportionately with the duration of the search, job role, and salary range.

Training costs

After you have found the candidate you want to hire, you need to invest in their training. This is another significant expense for the company. A recent study by the Training Magazine concluded that companies spend an average of $1,111 per employee on training.

During the training phase, employees generally cost more than they earn. When you consider the total cost of training, businesses typically lose money on an employee going through this phase.

Training cost is a sum total of the following costs:

• IT equipment: From operating systems to new PCs, IT equipment includes the expenses for all software and hardware required for training.

• Formal training: The inductions, boot camps, and certified courses that a company invests in for new employees make a significant addition to the training cost.

• Employee support: The support given by other employees to a new hire also comes at a cost. The time they spend in bringing a new team member up to speed leads to the division of time and loss of their productivity.

• Productivity loss: Until the new employee is fully adept at their job, the loss of productivity is also included in the total training cost.

According to the Human Panel, it takes between five and eight months for a new hire to achieve full productivity. This cost only goes up with seniority of job roles. Moreover, with employee turnover, these training costs can recur multiple times for each type of job, adding a significant cost to your business.

How much do benefits cost per employee?

The final cost of hiring an employee includes several items in addition to their salary. According to the U.S. Bureau for Labor Statistics (BLS), benefits for employees make up 31% of total costs. Benefits included in the final bundle of wages can range from simple perks like free coffee and parking to large investments like health insurance, medical plans, and disability coverage.

Some laws may impact the cost of hiring employees as well, such as the Affordable Care Act (ACA), which requires certain employers to provide their employees with health insurance, and the Family and Medical Leave Act (FMLA), which requires some companies  to provide unpaid family and medical leave to their employees.

You should also check your state’s labor laws for the latest regulations in your area.

Best practices when hiring employees to lower costs

Given the significant costs associated with hiring, you can see that onboarding new full-time employees can drain a company’s resources. Although there is no quick fix to lower your average hiring cost, you can take some simple steps to control your spending on recruitment and new hires.

Employee referrals

Referrals enable you to find candidates through the recommendations of your employees. Finding top talent is a daunting task that can be simplified by using your employees’ networks—after all, the best way to draw more hires into your company is through people who are already happy working there. Referrals can improve the quality of hires, increase employee retention, and, most importantly, reduce the time and money spent per hire.

Staffing without recruiters

You aren’t bound by traditional hiring methods when it comes to finding prospective applicants. Today, huge pools of talent populate job boards and networking platforms like LinkedIn—it’s only a matter of sifting through profiles to find someone with the skills your company requires.

When hiring managers don’t need to rely on outsourcing, they can save money and exercise more control in the hiring process.  

Build a talent pool

A talent pool is a database of candidates who have shown interest in working with your company in the past. Maintaining such a database saves time and reduces the costs that you would normally incur in the initial stages of hiring.

Attracting the right talent is a thorny problem for recruiters. Maintaining a talent pool reduces the need to rely solely on recruiters or staffing agencies and allows you to cast a wider net to find high-quality candidates.

Conduct group interviews

Group interviews are a quick and affordable way to interview multiple candidates for subsidiary roles while assessing communication, stress management skills, and ability to work in a team. You should consider conducting group interviews if you face a tight deadline to fill a position or if you have a large number of applicants for the same role.

Alternative staffing methods

Hiring and absorbing a full-time employee into your workforce is a sizable commitment of time and other resources. Depending on the nature of the work, you can explore alternative staffing methods, such as offering internships or using freelancers. This is often less expensive for the company, as the benefits accrued to a full-time employee don’t apply to these alternative staffing arrangements. This eases the burden on the company while allowing more flexibility.  

Get help hiring talented employees

For smaller companies, hiring an employee can be one of the biggest expenses. For larger companies, developing a cost-effective system of hiring is important for controlling costs. Every part of the process—from hiring to onboarding and training—comes with its own challenges and overhead costs. However, people are the key enablers of growth and success for your business, and hiring the right people is one of the most important decisions you’ll make as a business owner.