As a small business owner, one of your biggest financial decisions involves asking yourself the question, “How much should I pay my employees?” It’s a question most small business owners struggle with, especially those who don’t have a dedicated human resources department or who are hiring for the first time. But what to pay employees is an important question because according to a recent study by Glassdoor, 67% of job seekers consider salary to be a top factor in considering whether or not to take a job.
You want to hire and retain top talent, but you also need to create a business budget that allows your business to turn a profit and grow. So figuring out how much to pay your employees can be a balancing act. We’ll walk you through the best way to determine what to pay your employees. Here is everything you need to consider in order to pay employees appropriately while staying within your operating budget.
How much should I pay my employees?
There are myriad factors to consider. One guiding principle to keep in mind is that a salary is an investment—so make sure you don’t pay more than you feel you will get in return. A good rule of thumb is to put 40%-80% of your business revenue toward employee salaries.
That said, deciding how much to pay your employees is a huge question to answer and a lot goes into making that decision. We’re going to cover the factors you need to consider as well.
Decide your budget for total employee salaries
Before you go ahead and decide what to pay one employee, think about how much you want to spend on the salaries of all of your employees. In other words, determine what percentage of your business’s revenue should go to your employee’s salaries. Keep in mind that this is likely your biggest business expense. But creating this budget will help you be sure you’ll have the funds to pay your employees, offer raises, and hire if you’re looking to.
Estimates for the percentage of your business revenue that you should spend on employee salaries vary greatly, especially depending on your industry. The percentage of revenue a restaurant spends on salary will likely be very different than the percentage of revenue an accounting firm spends on salaries. Other things like the age and the seniority of your employees can impact the amount to budget as well.
When creating a budget for paying your employee salaries you should also take into consideration the taxes, benefits, overtime, paid time off, and any reimbursements you expect to have to pay to employees. All of these costs combined should be part of your budget. As such, it can all end up being anywhere from about 40% to 80% of your business revenue.
The fringe benefits you offer will also increase this budget but they’re extremely important, offering good fringe benefits is just as important as paying a fair salary. A Randstad survey revealed that 55% of employees left a job because they found better benefits elsewhere. The IRS defines fringe benefits as “a form of pay (including property, services, cash, or cash equivalent) in addition to stated pay for the performance of services.” This can include anything from social security and workers’ compensation to health insurance and paid time off. While it’s easy to think of a salary as the cost of employment, it’s essential you consider the cost of providing fringe benefits when trying to determine how much to pay your employees—lest you end up paying more in salary than what you had budgeted for. If you offer employee benefits such as health insurance, life insurance or a retirement plan, take the costs of providing these benefits into account. Their cost can equal 20% or 30% of an employee’s salary or wages.
All the while, know that your employees are still an investment for your business. So as you would with any money you’re putting into the business, think about the return on investment you’ll get from hiring a certain employee. Here are a few other things to consider:
How much time can that employee save you, and what is that worth to you?
If this employee is being hired for a more senior role, can they increase the ROI of other employees?
Can you afford to give this employee a raise if and when they ask for it?
What is the cost of onboarding this employee, both in terms of money and time?
Determining individual employee salaries
Once you have an overall budget for all employee salaries and benefits, you can start to look at what you’d pay one employee specifically. Most of the benefits will cost you the same regardless of the employee or their position, but the salary is what will vary much more. Here are some of the things to consider to determine an employee’s salary.
Type of job
The first thing you must do when determining what to pay your employees is write an accurate job description. This description should include the core duties of the job, the skills needed, and the level of experience required. You want the job description to be detailed enough that applicants can understand what they are applying for but it should also be generic enough that it can be compared to a similar job in your industry.
Note that job titles may not be specific enough to determine a pay range because roles can have different functions from one company to another. Writing a job description will help you make sure you’re comparing apples to apples when you research average pay.
The next factor to consider when trying to figure out what to pay employees is the average salary for comparable roles in your industry. There are a few different methods you can use to find out this information. The first is to perform internet research. The Bureau of Labor Statistics has a page in which they detail average pay rates for different industries and different regions. Websites like PayScale, Glassdoor, Salary.com, and LinkedIn also publish reports on salary data. We also recommend using keywords from your job description to get as specific as possible. For example, find out what the going rate is for key skills like bookkeeping or data research.
You also need to factor in the geographic location of your job to get an accurate idea of what to pay employees. The average pay for the same job can vary depending on the cost of living in certain locations or whether there are too few, or too many, qualified employees in the area. We recommend the help of other businesses and recruitment firms in your area to get a better understanding of the local market for the role you’re hiring for.
While your researching average pay, look for low, average and high pay rates for a job, and create a pay range you feel comfortable with. This gives you the flexibility to offer candidates with more experience or skills higher wages—if you determine that they are worth the investment.
Candidate pay expectations
Of course, the candidate will also come to the table with an expectation of how much you should pay them. This is why it’s important to enter salary negotiations with a range in mind. For a candidate who meets the essential qualifications of the role, you may want to offer them a salary in the lower to medium range of the average salary for the job. But for a candidate who exceeds expectations, you may try and entice them by offering a salary in the higher range.
Note that when you’re negotiating salary, you want to keep in mind what you think your ROI would be. If you offer a highly qualified candidate a higher range salary, do you feel they will deliver enough value to make your investment in them worthwhile? This is often one of the hardest questions to answer when figuring out how much to pay your employees, and it underscores the importance of doing your homework before making an offer.
Laws about paying your employees
There are obviously going to be plenty of factors to consider when choosing how much to pay your employees. The most important ones for you to follow are going to be the legal parameters for employee pay that help answer the question, “How much should I pay my employees?” We’ll go over the legal parameters you need to factor in when determining salary.
Exempt vs. nonexempt employees
When considering how much to pay your employees, it also helps to know the difference between exempt and nonexempt employees. The Fair Labor Standards Act (FLSA), the federal law that regulates employment policies, recognizes two types of employees. Exempt employees are not subject to minimum wage or overtime pay laws; they must be paid a salary—a set amount of pay no matter how many or few hours they work. Nonexempt employees are entitled to minimum wage and overtime pay. They’re typically paid hourly, but some are paid salaries. For more information on determining if an employee is exempt or nonexempt, see this Department of Labor fact sheet.
Generally speaking, the FLSA recognizes three main categories of exempt workers: Administrative, professional, and executive. These three categories are purposefully broad. Most other categories of an employee can be considered nonexempt, although not all are.
Exempt vs. nonexempt is only one part of the labor law that employers must comply with when determining how much to pay employees. The FLSA also sets specific minimum wage and overtime pay standards that you need to consider when asking: “How much should I pay my employees?” Many states also set their own minimum wages—and employees are entitled to the higher of the two minimum wages. New York, for example, currently has a minimum wage of $11.80, while Florida has a minimum wage of $8.46. The federal minimum wage is $7.25 per hour, meaning no state can pay less than $7.25 for a minimum wage job. The Department of Labor website has more information about minimum wage laws in each state:
For nonexempt employees, overtime pay at a minimum of one and one-half times the regular rate of pay is required after 40 hours of work in one workweek. The Department of Labor’s Wage and Hours division has tools you can use to calculate hours worked and overtime. (Some states, notably California, require overtime to kick in at more than 8 hours worked in a day).
If you want to pay employees, such as employees making craft items or garments, on a piece-rate basis, you can do so as long as the piece rate is at least equal to the minimum hourly wage rate (and overtime, if employees work more than 40 hours per workweek).
If your employees regularly collect more than $30 a month in tips, such as bartenders, waitresses or hairdressers, you can count tips as part of their wages, but you have to pay a wage of at least $2.13 per hour and meet some other requirements in order claim a tip credit. (See this fact sheet for more information.)
Some states, like California and Illinois, stipulate that you as an employer have to reimburse employees for work expenses. Not all states require this but more and more have been enacting laws that require employers to repay their employees for work-related expenses, think food while traveling or mileage for employees who have to use a personal car for work.
For milage, the IRS standard pay is $0.58 per mile for miles driven for business, this is to cover gas and wear and tear on the employee’s vehicle. The rate varies for some other industries, and while it’s not required by law to reimburse this money, its standard practice in business, along with other reimbursements as well.
The bottom line
When it comes to the question: “how much should I pay my employees?” hopefully now you have a better idea of where to start. Do research, learn about labor law compliance, and work out your budget. If you have any questions or concerns, run your plans by an accountant or attorney familiar with tax issues and employment laws. Remember that you’re not just assigning a number to a job, you’re hiring a person and you’re investing in your business. So while you want to keep your business’s interests in mind, you should also be fair and reasonable with your employees. After all, they are the ones who are going to help your business grow.
This article originally appeared on JustBusiness, a subsidiary of NerdWallet.