As a small business owner, you may reach a point where you realize you can no longer handle everything on your own. Hiring additional employees can be a significant financial investment, but it's often necessary to grow your business and meet the demands of your customers. In this blog post, we'll discuss the financial factors at play when deciding whether to hire a new employee, and provide two different examples to help you make an informed decision.

Financial Factors to Consider

Revenue

The most obvious factor, and likely what most people consider when determining whether or not to hire is the business revenue. Look at your revenue streams and determine if you have enough money to support the cost of a new hire.

To calculate the cost of a new employee, consider all of the expenses you'll need to cover. This includes the base salary, payroll taxes, workers' compensation insurance, and benefits such as health insurance and retirement contributions. You may also need to invest in additional equipment or software to support the new hire.

It's important to make sure that you can afford to pay for these expenses without putting your business's financial stability at risk. You should have a clear understanding of your business's revenue streams and a solid financial plan in place to ensure that you can cover the cost of a new employee. This is the reason that understanding and being able to project your business cash flow into the future is so important.

Productivity

Another important factor to consider is how much the new hire will increase productivity. Hiring an additional employee should lead to an increase in production, allowing you to take on more work and generate more revenue. When deciding if it makes financial sense to hire a new employee, you need to estimate the potential increase in productivity and revenue that they will bring to your business.

To do this, consider the tasks that are currently taking up your time and estimate how much more you could accomplish with an additional employee. Think about the projects or services that you could take on if you had more support. This can help you estimate the potential increase in revenue that a new hire could bring to your business. In some scenarios, like a manufacturing company or sales department, you should be able to calculate how much revenue will be added through additional productivity. So even if the immediate cash flow impact is negative, it may make sense to hire additional staff to take productivity to the next level. 

Demand

If productivity speaks to an internal financial consideration, its external equivalent is demand for your product or service. If you're struggling to keep up with customer requests and orders, obviously hiring an additional employee can help you meet demand and avoid losing potential sales. 

To assess demand, consider how much work you currently have and how much more you could take on if you had an additional employee. Again, having a firm grasp on your cash flow both historically and projected into the future is invaluable information in this regard.

Cost of Training

Finally, you need to factor in the cost of training a new employee. You'll also need to provide training to help the new employee get up to speed on your business's processes and procedures.

To estimate the cost of training, consider the amount of time and resources you'll need to invest in the new employee. This may include the cost of any training materials and courses, as well as the time you'll need to spend training the employee yourself, factoring in any temporary productivity loss and its impact on short term revenue. Going back to the cash flow and productivity considerations above, these cost factors should be able to be at least estimated and weighed against potential gains so that you can make an informed decision.

Let’s look at a theoretical example of the decision process above

Let's say you run a manufacturing company that currently has 10 employees. You've noticed that your current workforce is struggling to keep up with demand, and you're considering whether or not to hire an additional employee.

To determine whether hiring an additional employee makes financial sense, you'll need to calculate the additional revenue that the new employee could generate, as well as the cost of hiring and paying that employee. Let's assume that the new employee's salary would be $40,000 per year, and that their role would be to operate a machine that produces a product that sells for $10 per unit.

Assuming that the new employee can operate the machine for 2,000 hours per year, and that each hour of machine time produces 10 units of product, the new employee could produce 20,000 units per year. If each unit sells for $10, the new employee could generate $200,000 in additional revenue per year.

However, you'll also need to factor in the cost of hiring and paying the new employee. In addition to the $40,000 salary, you'll need to consider the cost of benefits such as health insurance, as well as any payroll taxes and other expenses. Assuming a total cost of $55,000 per year, the new employee would need to generate at least $55,000 in additional revenue to break even.

If your company's profit margin on each unit is 50%, the new employee would need to produce at least 11,000 units per year to break even. If you believe that the new employee can produce at least 1,000 units per month, or 12,000 units per year, then hiring an additional employee would likely be financially feasible.

To summarize:

Based on these estimates, the manufacturer's decision to hire an additional employee would result in a return on investment of approximately 2.18x, meaning that for every dollar invested in the new employee, the manufacturer can expect to generate $2.18 in additional revenue. 

It’s important to remember that these numbers are simplified estimates to illustrate an approach to the calculation of adding a new employee. This will vary depending on the specific circumstances of a business, and in most cases are not as cut and dry in terms of the calculated risk involved. Additionally, non-financial factors should also be considered when making a decision about hiring an additional employee, for example the impact on team morale by adding another employee, or the specific personality of the new hire. By taking a holistic approach and carefully weighing the potential risks and rewards, you can make an informed decision about whether or not to hire an additional employee that aligns with your overall business strategy and goals.