Mastering the Equation: A Step-by-Step Guide to Calculating Headcount Costs
A fast growing company can get easily carried away with equally growing expenses, and human labour is often among the highest of costs.
With staffing costs representing about 70% of operating expenses, on average, according to the Human Capital Management Institute (HCMI), companies especially need to keep track of headcount cost as they expand.
However, headcount costs encompass more than just salaries and wages. They also include the comprehensive expenses associated with maintaining a workforce, including recruitment, training, benefits, and even potential costs related to employee turnover.
Understanding the intricate dynamics of headcount costs is essential for businesses to make informed decisions about their human capital investments, resource allocation, and long-term financial planning.
In this article, we will consider what headcount cost is all about and how companies can use this information to improve their profitability. We’ll cover:
- What is headcount cost?
- Cost per head calculation
- Headcount cost analysis: Why you should calculate headcount cost in your business
[Do you want a digital payroll system that can help you better understand headcount cost? Request a demo to see how NOW Money’s flexible, smart, and cost-effective payroll software can help improve your organisation.]
1. What is headcount cost?
To understand what the headcount cost is, we need to say a few words about “headcount.”
Employee headcount is the total number of employed workers in a company or in a department. While some companies only focus on a department-level headcount, others do a company-wide headcount. But the two are not mutually exclusive: it’s possible to do a department-level and a company-wide headcount and use them for different purposes (as we will soon see).
By workers, we refer to full-time employees (FTE) and part-time employees, among others. The UAE’s labour law recognises five different types of workers: full-time, part-time, flexible, remote, and temporary workers.
All of these will be included in the headcount.
The headcount cost is how much it costs the company to have the total number of workers it currently has. However, some also define the headcount cost as the average cost of one worker.
There is no serious difference here. One looks at the cost from a cumulative perspective while the other does it from an average perspective. For example, if firm A has 2,000 workers and a total workforce cost (headcount cost) of AED 5,000,000, some will consider AED 2,500 (AED 5,000,000/2000) as the headcount cost while others will take AED 5,000,000.
For clarity, we will use headcount cost (or total staff cost) to refer to the cumulative cost and cost per head for the average cost.
2. Cost per head calculation
The basic idea behind headcount cost is that an organisation’s cost of maintaining the number of workers it currently has goes beyond the salary/wages it pays them at the end of a pay period.
These other costs are often referred to as the hidden employee cost.
HCMI provides three broad headcount cost categories: compensation, benefits, and others.
This includes the basic pay, commissions, bonuses, and overtime payments that workers receive from the organisation. Compensation as part of headcount cost is often evident and many firms tend to focus entirely on it.
But it costs the firm more to maintain its headcount. There are also benefits like insurance, paid leave, and retirement benefits.
For example, health insurance for employees is mandatory in Dubai and Abu Dhabi and other Emirates are deemed to follow suit in 2023. The cost of providing such benefits is part of the headcount cost.
Similarly, the labour law recognises different paid, partially paid, and unpaid leave. All the paid and partially paid leave a company provides should also be part of its headcount cost.
Also, any employer contribution to employees’ pension funds is a benefit that must be part of the headcount cost.
This category is where most hidden employment costs are captured. In fact, this portion of the headcount cost can be the largest in some companies.
- Recruitment and onboarding cost
- Staff training cost (including certifications)
- Feeding and travel
- Payroll processing fee
- Communication and software licences
- Cost of working space and other work facilities
- Employer payroll taxes
Some organisations have proposed simpler ways to go about the cost per head calculation. For example, Time Camp, a time-tracking app provider, suggests that we can get the total cost of an employee by multiplying the base salary by 1.2 and 1.4. The former will give us the minimum value and the latter the maximum value.
So, if Ahmed’s base salary is AED 50,000, then his total cost is between AED 60,000 and AED 70,000. One can then repeat this process for all the workers to get the headcount cost (sum of the total cost of every employee).
Others like Toptal, a freelance marketplace, have suggested a 2X multiplier. The company also provides a true-cost-of-employee calculator where users can input their own multipliers.
Though this method is simple, it will not yield the most accurate results. Therefore, it is better for organisations to take the more complicated path for the sake of accuracy.
Steps to calculating headcount cost and cost per head
So, how can you get started calculating headcount cost and cost per head? Follow these simple steps:
- Select a time period: It’s obvious that headcount cost will vary depending on what time period a company is considering. Monthly and yearly headcount costs will differ.
In today’s business environment, monthly, quarterly, and yearly figures seem to be the most important for planning and control; therefore, it might be useful to use the three time periods.
- Get all the needed financial reports: If the accounting and finance department is keeping proper records, then it should not be hard to get needed financial reports (monthly, quarterly, and yearly).
- Add compensation, benefits, and other staff costs: The HR staff involved in this process can then add up all the money spent on compensation, benefits, and other staff costs for the given time periods.
If the time period in focus is a month, then annual costs (say the company pays rent once a year) can be prorated (divided by 12) to get a monthly figure. And if it’s the other way around (e.g, monthly salary), monthly costs can be multiplied by 12 to get a yearly figure.
- Divide headcount cost by number of workers: By now, the firm should have its headcount cost for a given period. To get cost per head, all it needs to do is divide that headcount cost by the number of employees.
3. Headcount cost analysis: Why you should calculate headcount cost
But why go through all the stress of calculating headcount cost and cost per head?
Well, there are various planning, control, and decision making purposes that these data can serve.
Cost of replacing an employee
Headcount analysis can help companies realise the cost of losing one employee and replacing them with another.
On the surface, it might seem that you’re just paying the same salary to a different account number. However, as we have seen, there are other relevant costs. In this instance, there is (at the minimum) the recruitment cost, onboarding cost, and training cost to consider.
Every time a company recruits new staff, all these three costs will increase, leading to higher headcount cost and higher cost per head.
In fact, according to Centric HR, employers can expect these extra costs (their calculation includes salary differential) to equal:
- around 16% of the employee’s salary for high-turnover, low-paying jobs.
- around 20% of the employee’s salary mid-range positions
- around 213% of the employee’s salary for executive positions
And this is not adding qualitative costs like what it takes for a new employee to get used to the job and company’s culture.
Knowing that it is cheaper to retain workers than replace them, companies have now found it imperative to reduce turnover rate by improving employee retention. This has meant improving work-life balance, creating a happy workplace, enforcing diversity and inclusion, and effectively managing mental health.
In the UAE where most of the workforce are expats, the ability to easily receive their remuneration and send some of it back home is key to happiness. This is why NOW Money sought to bank the unbanked by providing free mobile bank accounts through which they can receive their wages and salaries and also send money back home.
Measuring the value of an employee
Companies also use cost per head to determine if a worker is valuable to the company.
Cost per head is what the employee costs the company for a given period. They can then compare this figure to what they believe is the financial value (using various productivity metrics) that a particular employee brings within the same period.
If cost exceeds value, then the company might put in strategies to improve the value of the employee or consider replacing the employee (after factoring in the cost of replacement).
When a company is making plans to grow, they need to prepare financial models that will show the amount of money they need to fund the growth.
In most cases, growth will lead to hiring plans, which will increase the headcount (number of workers). Therefore, headcount forecasting must be part of the planning process.
Since they know the average cost of one employee, they can forecast what future headcount cost will be by multiplying current cost per head with the new headcount. The result is the future headcount cost.
Similarly, startups can use this same template to do their workforce planning. They can look at the average cost per head of companies of similar size and multiply that by the number of employees they need. The result is their expected headcount cost.
The more competitive an industry is, the more attention companies have to pay to cost control.
Since headcount cost is the largest portion of most companies’ costs, any effort at cost control will include cutting it down.
Many companies use benchmarking to determine when headcount cost is excessive. They can benchmark against the industry average, a certain percentage of revenue (e.g, headcount cost should not exceed 60% of operating expenses) or an average figure from previous years.
When headcount cost exceeds benchmark, organisations have to create initiatives to reduce it, for the sake of competitiveness and profitability.
This can include using digital payroll software instead of manual processing to reduce payroll processing fees.
Some organisations have also outsourced their recruitment to external agencies while others have changed some full-time jobs to temporary jobs.
Automating repetitive and standardised tasks has also worked for many firms.
What headcount cost does here is that it helps companies realise that there are many opportunities to reduce costs (recruitment cost, training cost, etc.) that can be considered before deciding to reduce the wages/salaries of workers.
In a previous section, we mentioned that firms can do a department-level or a company-wide headcount cost analysis.
Companies can use this to compare the value added by each department (based on certain productivity metrics and KPIs) with the cost of maintaining its staff. This can be used to identify the most efficient and least efficient department, a distinction that will become important in cost control.
Whether at a department or a company level, organisations must keep an eye on their headcount cost as an essential factor in their competitiveness.
As we have seen, payroll processing fees are also a component of this calculation and a switch to digital payroll software can help reduce your headcount cost.
In addition to reducing your payroll processing cost, with an efficient payroll system like NOW Money, you can pay workers’ remuneration in a timely fashion, which will increase their satisfaction and make them more willing to stay (remember, retention is cheaper than replacing workers).
[Do you want to use payroll software that will reduce your headcount cost and improve employee retention? Request a demo to see how NOW Money can transform your payroll system.]
- The headcount cost is the amount an organisation spends on its workers within a period of time.
- Cost per head is the amount spent on each worker within a given period. It is the headcount cost divided by the number of people employed.
- By including otherwise hidden employee cost, headcount cost helps companies gain a better perspective on what they spend on human resources.
- Companies use headcount cost to determine the cost of replacing an employee, to forecast the future, reduce cost, and measure the value of an employee.