When hiring a new employee, you should consider the overall cost to your business. But how can you budget for hourly employees, who may work more or less as circumstance demands? By understanding your business's needs and a few payroll accounting principles, you can determine the average cost of an hourly employee to your business, helping you develop a more strategic hiring plan.
What is an hourly employee?
An hourly employee is paid a predetermined rate for the number of hours they work. The pay can be issued weekly, biweekly, semimonthly or monthly. If an hourly employee works over 40 hours per week, they are entitled to overtime pay.
Since the amount of time an hourly employee works may vary from week to week, their pay may fluctuate. This is why budgeting for an hourly employee can be difficult, especially as your business grows.
Manually running payroll can quickly become too much to manage when you're budgeting for hourly workers. If you are looking to automate your payroll, read our reviews of the best payroll software providers.
How does hourly pay work?
State and federal law requires employers to pay hourly employees a minimum wage. While wage requirements vary from state to state, employers must pay either the state or federal minimum wage, whichever is higher.
Do hourly employees get benefits?
Benefits are expected for full-time hourly employees. These benefits may include paid vacation and sick time, healthcare coverage options, life insurance, and retirement savings plans. It is not uncommon for hourly employees' benefits to be less comprehensive than those for salaried employees.
When benefits are available to hourly employees, companies frequently require the employee to complete a certain number of days before receiving benefits. The trial period gives the company time to train the employee and ensure they understand the job. The chance to earn benefits serves as an incentive for new employees to perform well, while the company can feel confident the employee is a worthwhile investment and a good fit.
Should you hire hourly employees vs. salaried employees?
While hourly workers are paid for time logged, salary workers receive a set compensation package that is not affected by hours. You will need to weigh the pros and cons of hourly vs. salary employees to see which type of employee is best for your company.
Hourly employees
Hourly employees are closely monitored for the hours they work each week. If an hourly worker stays at or below 40 hours every week, you will not have to give them any additional pay. However, if you are frequently shorthanded or have a boom in business, paying hourly employees overtime (time and a half or double time) can add up quickly.
Hourly employees are also helpful when you run a retail or service business that has set hours. Flexible schedules with set days or hours for each employee help prevent overtime.
If your business is typically busy during holiday seasons, hiring hourly workers makes sense as long as your increased profits can offset additional labor costs. Hourly workers are more likely to work during holidays when an incentivized paycheck is available.
Salaried employees
On the other hand, salaried workers work for a flat rate each week, no matter how many hours are necessary. If you regularly need extra responsibility or extra hours from your employees, paying a salary could save you money.
Salary employees are also helpful if your business does not have set hours and you need employees on call 24/7. Salaried workers don't need to track their working hours, so if any issues arise, they can fill the gaps without depleting your financial resources.
Overtime pay
Once an hourly employee passes 40 hours in one week, they are entitled to overtime pay. Every hour worked after that is considered overtime, meaning employers must pay more per hour by law.
Overtime pay is generally 1.5 times the employee's regular pay. For example, if an employee who makes $12 an hour works 45 hours in one week, they would receive $12 an hour for the first 40 hours and $18 an hour for the remaining five.
The workweek can start on any day of the week as long as it is consistently calculated on the same day. The Fair Labor Standards Act defines the workweek as a "fixed and regularly recurring period of 168 hours – seven consecutive 24-hour periods."
The exception to this rule is hospitals and residential care facilities. These facilities are allowed to calculate hours based on 14 consecutive days rather than the standard seven-day period. For example, a nurse might work 35 hours one week and 45 hours the next, for a total of 80 hours. The nurse would not be paid overtime for working additional hours in the second week, since the total number of hours averages out to no more than 40 hours per week.
Exempt employees
The majority of hourly workers fall into the nonexempt category, qualifying for overtime pay. Exempt employees do not receive overtime pay. In this case, the employees are highly compensated for their work, and overtime hours are accepted. Exempt employees include truck drivers, taxi drivers and salespeople.
Exceptions to the rule
In some cases, an employer provides additional financial compensation for exempt employees. The law limits compensation options, but it may include a flat amount, percentage bonus, or extra paid or unpaid time off.
What are the benefits of hourly employees?
The advantage of hourly employees is that you only pay them for the hours they work. During slow times, an hourly employee will be less of a strain on your business's finances than a salaried employee.
When overtime is necessary, the hourly employee will make significantly more income, as overtime is at least 1.5 times the hourly rate. However, when overtime is offered to an employee, it is usually because the expected profits offset the additional labor cost. Plus, hourly employees usually don't mind working holidays for overtime pay, whereas salaried workers make the same amount regardless of the days or hours they work, so they have little incentive to work holidays.
How can you calculate hourly employees' earnings?
You calculate hourly employees' earnings by adding up the gross wages and deducting any tax requirements, voluntary and involuntary deductions, and adding back any business-related reimbursements.
Gross wages
To calculate gross wages for hourly employees, you multiply the number of hours they worked by their hourly pay rate. For example, if your employee makes $15 per hour, and they completed 35 hours this week, this would be their gross pay calculation:
35 (number of hours worked) x $15 (hourly pay rate) = $525 (gross pay)
When calculating gross wages, keep in mind that commission, overtime and tips will increase the final total. For example, if the same employee works 45 hours in one week, this would be the pay calculation:
40 (number of hours worked) x $15 (hourly pay rate) + 5 (number of overtime hours) x $22.50 (overtime pay rate) = $712.50
Tax requirements
Employers can withdraw money directly from an employee's paycheck to cover benefits. Employees who elect these paycheck withholdings can lower their taxable wages, reducing the amount they owe for federal income taxes.
Pretax withholdings:
- Retirement contributions
- Health care
- Child care
Employee taxes:
- Social Security tax
- Medicare tax
- Federal unemployment taxes
- State unemployment taxes
- Local income taxes
Voluntary and involuntary deductions:
- Child support
- Wage garnishments (including court-ordered)
- Uniform or tools
- Tuition or certification
- Health insurance premiums
Reimbursements:
- Mileage
- Food
Keeping track of tax changes, deductions and payroll responsibilities can be overwhelming. Check out our review of Gusto and our Paychex review. Both are top automated payroll solutions that can take the stress out of paying your employees accurately and on time.