How to Determine Employee Compensation for Small Businesses on a Limited Budget
Here are some practice ways to look at your finances, create a budget, and make use of some common calculations to determine what you can afford to invest in your employees.
Assess Your Finances:
- Analyze Income Streams: Review your current revenue streams and (realistically) project future earnings. Consider both fixed and variable income sources to gain a comprehensive understanding of your cash flow. Since I process all income through PayPal currently, I pull the .csv reports and add them to an income tab in a live spreadsheet, like Google Sheets.
- List Out Expenses: Pull reports on all expenses. Identify areas where you can cut back without affecting business operations. I also put all of this data into a live spreadsheet in an expenses tab and mark each expense as either vital or not. This will come in handy for the next step.
- Analyze Income Streams: Review your current revenue streams and (realistically) project future earnings. Consider both fixed and variable income sources to gain a comprehensive understanding of your cash flow. Since I process all income through PayPal currently, I pull the .csv reports and add them to an income tab in a live spreadsheet, like Google Sheets.
Build a Comprehensive Budget:
- Fixed Costs: List all essential fixed expenses like rent/mortgage, utilities, insurance, loan payments, digital tools & maintenance costs, etc. Make sure these costs are factored into your budget as non-negotiable expenses. I find these in the expenses tab of my spreadsheet and mark them accordingly (I simply write “vital” or “NV” in a designated column of that line item’s row to denote if that expense is necessary or not).
- Variable Costs: Account for fluctuating expenses, like inventory, marketing, events, or maybe even seasonal labor needs. I like to average these out and round up a bit. Having a contingency fund for variable costs can help you navigate unpredictability.
- Emergency Fund: Include a buffer in your budget to handle unexpected expenses and avoid compromising employee compensation during challenging times. This amount will vary from business to business, but building a savings of about 3 months worth of operating costs is a pretty common rule to follow. A common percent of monthly income to save is around 10%, but again, it varies. And for some businesses this could take less than a year, for others it may take 3 or more years.
- Fixed Costs: List all essential fixed expenses like rent/mortgage, utilities, insurance, loan payments, digital tools & maintenance costs, etc. Make sure these costs are factored into your budget as non-negotiable expenses. I find these in the expenses tab of my spreadsheet and mark them accordingly (I simply write “vital” or “NV” in a designated column of that line item’s row to denote if that expense is necessary or not).
Consider Industry Standards:
- Research Comparable Salaries: Investigate industry standards for employee compensation based on roles, experience, and location. Use this information as a benchmark to guide your decisions. The classics like Indeed or Glassdoor are both great resources for this, though there are some industry-specific job sites that may be more applicable to you.
- Competitive Compensation: Of course you want to offer competitive wages that attract and retain skilled talent while staying within your financial means. But keep in mind, compensation is not limited to paychecks. More on that below and here.
- Research Comparable Salaries: Investigate industry standards for employee compensation based on roles, experience, and location. Use this information as a benchmark to guide your decisions. The classics like Indeed or Glassdoor are both great resources for this, though there are some industry-specific job sites that may be more applicable to you.
Use Common Calculations:
- Percentage of Revenue: Many small businesses allocate ~30% of their revenue for employee compensation. Your determination may be different.
- Gross Profit Margin: Calculate your gross profit margin (GPM) by subtracting the cost of goods sold (or the cost associated with the service you provide) from total revenue and dividing the result by total revenue. Use your GPM to estimate the portion that can be allocated to payroll.
- Labor Burden Calculation: Add expenses like payroll taxes, benefits, and other indirect labor costs to each employee’s salary. This calculation provides a more accurate representation of the true cost of an employee.
- Percentage of Revenue: Many small businesses allocate ~30% of their revenue for employee compensation. Your determination may be different.
Prioritize Roles and Responsibilities:
- Key Positions: Identify critical roles or individual tasks that drive your business’s success. Allocate a larger portion of your payroll budget to retain top talent in these positions.
- Entry-Level Positions: For roles that require less experience or responsibility, consider starting with more affordable compensation and the potential for growth as the business prospers. Keep in mind that some on-the-job training and continuing education costs may be tax deductible.
- Key Positions: Identify critical roles or individual tasks that drive your business’s success. Allocate a larger portion of your payroll budget to retain top talent in these positions.
Be Transparent with Employees:
- Communicate Clearly: Be transparent with your employees about your financial limitations and how you’ve determined their compensation. Encourage an open dialogue about future growth and the potential for salary adjustments. Also be open to hearing their suggestions for other ways they can feel and be compensated for their work. Remember that employee compensation is not limited to money.
- Offer Perks and Benefits: In lieu of high salaries, consider offering other non-monetary perks such as flexible work hours, remote work options, or opportunities for professional development. Read more on hiring talent on a budget here.
- Communicate Clearly: Be transparent with your employees about your financial limitations and how you’ve determined their compensation. Encourage an open dialogue about future growth and the potential for salary adjustments. Also be open to hearing their suggestions for other ways they can feel and be compensated for their work. Remember that employee compensation is not limited to money.
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