It’s the Spread

“Thirty six thousand dollars!”

“You’re proposing to pay him thirty six thousand dollars a year? We can’t afford that.”

“It will be tight, but I’m pretty sure that’s what it will take to get him. I really like this candidate.”

Discussions such as this happen all the time in small businesses. The company is in a hiring mode, the recruiting and interviewing has happened, and now it’s time to narrow it down to a specific candidate and make an offer.

It can be agonizing. I’ve been there and I’ll bet you have, too. Help is desperately needed but the best candidate seems too expensive. Heck, maybe any candidate seems too expensive.

Let’s listen in on the discussion the other interested parties in this situation are having:

“Thirty six thousand dollars!”

“Honey, you were making forty thousand when you were laid off. I don’t think we can afford to accept thirty six.”

“It will be tight, but I’m pretty sure that’s the best they can do. I really like this company.”

Two sets of people on either side of a salary negotiation. Both are looking at the same number and of course considering things from their vantage point, and with their own interests in mind.

The number they’re all focused on – annual salary – is the number we all use. Employers use annual salary to measure the cost to the company, and employees use it as the measure of compensation received.

But let’s dig deeper. What’s the real, full cost to the company for a $36,000 per year employee?

Salary                               $36,000
Plus payroll taxes           $  3,750
Plus benefits                    $  6,000
Total cost to company:  $45,750

What appears to be a $36,000 cost is in reality going to cost the company almost $46,000.

Now, let’s look at the employee’s side of the ledger.

Salary                                                           $36,000
Less payroll taxes                                        $  2,754
Less income tax withholdings                    $  7,200
Less employee’s share of benefits cost     $  1,000
Employee take-home:                                 $25,046

To drive home the point:

Employer cost                                  $45,750
Less employee take-home              $25,046
Difference                                          $20,704

That’s quite a spread between the company’s actual cost and the employee’s actual spendable net.

I suggest that these are the two numbers that deserve the attention of the folks involved. In this light, the annual salary almost becomes meaningless.

Yet, time and energy are spent negotiating a number that has little real-life importance.

I know – we won’t stop talking about annual salary. Too much pride is tied up in that number, and it is admittedly a convenient yardstick.

To me, the big deal is the spread. Here are the take-aways:

  •  Employees deserve to know what it costs their company to employ them, and the total value of their compensation package. Let’s tell ‘em.
  • Both employers and employees can help reduce the spread. For instance, employers can choose pre-tax benefits, reducing payroll tax. Employees can make healthy choices and wisely spend deductibles and company-provided benefit dollars.

I’d rather spend my time cooperating with employees to reduce the spread than arguing over annual salary. How about you?

No Sweat Compensation Planning

You’re sitting in your office, and like most business owners, you’re up to your elbows in a variety of challenges and opportunities. Suddenly, one of your employees appears at your door and asks the dreaded question, “Since my anniversary date was two weeks ago, am I due for a review and a raise?”

You buy some time by telling the employee you plan to work on it within the next few days. But you can’t help feeling guilty. First, you just lied because until you were reminded, you had no idea that the review was due and had no intention of addressing it. Second, you feel a sense of guilt because your lack of a systemized approach to reviews and raises repeatedly ruins your schedule.

As if this wasn’t enough, the next interruption is your accountant who brings the news that salary expense is way over budget, ending with, “Oh, and by the way, we just got our health insurance renewal. It’s going up 22% next year.”

Most small business owners operate in exactly this fashion. The employee anniversary date, by default, creates the expectation of a raise. (Reviews are generally dreaded by all involved, but as part and parcel of an annual raise, they go along for the ride.) Health insurance and other compensation-related expense increases take us by surprise. We’re supposed to be in charge of our companies, but we’re at the mercy of employees, vendors, and arbitrary schedules.

It doesn’t have to be this way.

How about a system that lets you take charge of schedules, accurately budget for increases in salaries and benefits (and actually stay within that budget), and eliminates the constant stream of mid-year raises?

Sound too good to be true? Read on.

First, who says that an employee’s anniversary date has to trigger a review or a raise? I suggest you do two things:

  1. Perform all the performance reviews in your company within a 2-3 month timeframe, near the end of your fiscal year.
  2. Schedule all pay raises to kick in at the same time – the beginning of the new fiscal year.

What does this do for you? For one thing, it eliminates the constant stream of interruptions and unplanned, hastily-prepared reviews (which hopefully equates to better, more thoughtful reviews.) It also gives you the structure to proactively look at your entire team and corresponding salary expense at one time, and to take the time to budget this expense for the new year.

Yes, it can be a lot of work. Yes, it requires plenty of discipline and organization. But in my mind, the benefits outweighs the costs. You’ve got to do this work anyway, right?

Here’s another change to consider: Try to move your health insurance and other benefit renewals to coincide with the start of your fiscal year. Then, by the time you’re doing your annual planning and budgeting for the new year, you’ve got your renewal quote in hand – ready to be plugged into your budget.

Finally, here’s the biggie: Lump ALL of your compensation-related expenses and focus on that number, and not just on the salary expense. Aim to keep this number growing more slowly than revenue. Better yet, manage to keep it growing more slowly than your gross profit. After all, that’s the number that pays all your overhead expenses.

So, if in the past you tried to have an average annual salary increase of 4%, consider having an annual total compensation expense increase of 4%.

This way of thinking requires some trade-offs. If health insurance is going up a bunch, it may eat up some of the funds that would otherwise be available for raises.

This approach also requires you to have some frank discussions and some educational sessions with your employees. Most are probably unaware that you pay FICA, Medicare and unemployment taxes. They may not know about your cost for their health insurance, worker compensation insurance and other benefits. One way to drive home the total cost to the company is to prepare a year-end summary for each employee, detailing each compensation-related expense.

Eliminate the chaos and take control. Spend some quality time once a year doing this admittedly hard work, and the rest of the year you can focus on growing your business.

Track Your Numbers Manually

One of the best things to happen to small businesses – heck, to businesses of any size – is computerized accounting.

Can you even imagine someone sitting down with a two-column ledger book and documenting each individual sale, line by line? It’s the way companies did it for centuries, until recently. We’re fortunate to be living and running our businesses in the modern era.

Despite my high praise for computers and all the things they can do for your business, I still urge you to manually compute your most important numbers. That’s right – use a calculator and a pencil and write them down. Every month.

Here’s why:

It’s so easy to nonchalantly look at a report – like a computer-generated income statement or balance sheet – and put it aside. Critical numbers don’t necessarily jump off the page at you.

In fact, your basic reports may not even give you certain important ratios. If you track revenue per employee, the ratio of current assets to current liabilities, and other key ratios, you may well have to calculate these manually.

My recommendations:

  • Determine what numbers, ratios and other key performance indicators are important enough to track monthly.
  • Set an acceptable range – maybe even specific high and low “red flag” limits – for these indicators.
  • Create a routine for this work. Set aside some time, and use the same format each month. You might do your calculations in the margins of your computer-generated reports, you may use a blank sheet of paper, or you might design a fill-in-the-blanks form. It doesn’t matter how you do as much as that you do it.
  • Working from your computer reports, find the numbers that you’ll need and do your calculations. Do it religiously each month.

If everything is within acceptable range, terrific. Celebrate with your team and maybe even give out some sort of reward for a job well done.

When you find numbers that are out of whack, spring into action and do something about it.

Of course, timely monthly reports are key to making this work. If you’re getting your reports weeks after the month closes, that is a problem that also needs to be tackled.

Using this simple and low-tech approach, you’ll quickly develop a “feel” for your numbers and will stay on top of problems while they are still small and manageable.