A guide to employee hiring costs for small business owners

Hiring your first employee is a significant milestone for your business, but it’s important not to rush into it. Carefully considering the costs involved in bringing on an employee will help you make a well-informed decision.

Why understanding employee costs is important

Transitioning from a solo business owner to an employer can be challenging. Once you hire someone, your responsibilities change—you now have wages to pay regularly, and your employee is depending on you to support their livelihood.

There are many hidden costs associated with hiring, which vary depending on your business and approach. For instance, if your new hire needs specialised tools or equipment, your expenses will naturally rise.

To help you decide if hiring is feasible for your business, we need to examine costs like salaries and National Insurance contributions, which apply across all businesses regardless of industry or hiring method.

Keep in mind that you may need to budget for additional expenses like equipment, recruitment, and training to get your new hire up to speed.

The main employee costs for small businesses

Understanding the costs of hiring an employee is crucial to determining if you can afford to bring someone on board. As an employer, you’ll be responsible for the following recurring expenses regardless of your business size or industry.

Salary and wages

Salaries will make up the bulk of your expenses, but these can vary greatly depending on the employee’s age and skill level. The government’s National Living Wage or National Minimum Wage sets the minimum pay.

Employer contributions

Employer’s National Insurance Contributions (NICs): 13.8% on any salary above the National Insurance Secondary threshold of £9,100 (with potential reductions using the government’s Employment Allowance). An employer paying an annual salary of £25,000 will incur extra cost of £2,194 ((£25,000-£9,100)*13.8%). 

Auto-Enrolment Pension Contributions: Minimum total contribution of 8% in the 2024/25 tax year, with at least 3% from the employer and the remainder from the employee. Paying an employee a salary of £25,000 will add £750 (£25,000*3%) extra cost to the business.  

Overall, hiring an administrator on a £25,000 annual salary will add £2,194 extra cost to the business a year.

Employee entitlements

While you will be paying your employees regularly, they won’t work every day, as they’re entitled to:

Holiday pay 

UK holiday entitlement requires budgeting for nearly six weeks’ worth of salary for holiday pay.

Sick pay

You’ll need to pay eligible employees £116.75 per week for up to 28 weeks if they claim Statutory Sick Pay (SSP). An employee that is entitled to a Statutory Sick Pay will get paid £3,269 for 28 weeks. This means the business will have to find the extra expense as well as finding an extra person to cover the sick employee.  

Maternity or paternity pay

This can extend up to 52 weeks, so planning is crucial.

Hidden costs of employing staff

When hiring employees, small business owners often focus on salaries and wages, but hidden costs can significantly impact overall expenses. Beyond the main costs detailed above, you will incur other hidden costs.

Hiring, training, and retaining employees

The need for employment contracts, documents, HR policies, and other procedures to recruit, train, upskill, and retain valuable employees will inevitably cost your business. These costs will depend on your choices, for example, posting a job on a site like Reed is relatively inexpensive, but using a recruitment agency could cost 10-15% of the employee’s salary.

Despite the increased responsibility, hiring an employee is an excellent way to grow your business, add new skills to your team, and free up your time.

Payroll admin costs

Running payroll is a critical yet often underestimated expense for small businesses. The costs include more than just processing employee salaries. Businesses must factor in the time spent managing payroll internally, the cost of payroll software or external services, and compliance-related expenses. For small companies, software subscriptions like QuickBooks or Xero can range from £10 to £30 per month per user, while outsourcing payroll services might cost £5–£15 per employee per month depending on complexity. 

Additionally, businesses need to ensure compliance with HMRC regulations, such as accurate PAYE (Pay As You Earn) submissions, which may require expert input or additional training for in-house staff. Mistakes in payroll processing can lead to fines, further increasing the hidden costs. That is why you should hire an accountant to run your payroll.

Employers’ liability insurance

Employer’s liability insurance is a mandatory cost for most UK businesses with employees, designed to protect businesses against claims made by staff who sustain work-related injuries or illnesses. For small businesses, premiums typically range from £60 to £250 annually, depending on factors such as the type of work undertaken, number of employees, and the associated risks.

 High-risk industries, like construction, usually face higher premiums due to increased likelihood of accidents. Failing to secure adequate coverage can result in fines, making it a non-negotiable expense. Investing in the right policy not only ensures compliance but also safeguards the business from significant financial liabilities in case of legal claims.

Other hidden costs

Equipping employees for their roles involves more than meets the eye and can represent a significant hidden cost for small businesses. Essential items like computers, smartphones, or industry-specific tools and machinery can quickly add up, especially for new hires. For example, a basic laptop suitable for office work may cost £500–£1,000, while more specialized equipment could be significantly higher. 

Beyond the initial purchase, there are ongoing maintenance costs, such as software subscriptions, repairs, and upgrades, which can range from £100 to £500 annually per employee. Businesses also need to consider costs associated with providing a safe and ergonomic workspace, such as desks, chairs, and monitors, particularly for hybrid or remote setups. Planning for these expenses upfront can help small businesses avoid budget strain and ensure employees have the tools they need to work efficiently

How to calculate employee costs for small businesses

Calculating employee costs accurately is crucial for small businesses to budget effectively and ensure profitability. Begin with the employee’s gross annual salary as the base cost. Add employer National Insurance Contributions (NICs), typically 13.8% of earnings above the threshold (£9,100 per year in 2024), and include pension auto-enrollment contributions, generally 3% of qualifying earnings. 

Factor in additional benefits such as holiday pay, bonuses, or private health insurance, along with operational costs like training, equipment, and workspace expenses. The total cost can be calculated using the formula:

Total Employee Cost = Gross Salary + NICs + Pension Contributions + Benefits + Overheads

For example, an employee earning £20,000 annually would have NICs of approximately £1,510 (13.8% of £10,900) and pension contributions of about £330 (3% of £11,000). Including estimated overheads of £2,000 for equipment and workspace, the total annual cost rises to around £23,840. Dividing this by the standard annual working hours (e.g., 1,800) gives a cost-per-hour figure of approximately £13.24. Using payroll tools or consulting an accountant can ensure accuracy and simplify this process.

Tips for small businesses to manage employee costs

Managing employee costs effectively is essential for small businesses to maintain profitability and cash flow. Here are some practical tips for cost management:

1. Embrace Flexible Work Arrangements: Consider offering remote work or part-time roles where feasible. This can help reduce overheads such as office space, utilities, and associated equipment costs.
2. Leverage Tax Benefits and Government Schemes: Take advantage of programs such as the Employment Allowance, which reduces your National Insurance Contributions, and salary sacrifice schemes that allow employees to trade salary for non-cash benefits, saving both the business and employee on tax and NICs.
3. Streamline Payroll and HR Processes: Use affordable payroll software or services to reduce administrative costs and the risk of compliance issues. Automating processes can minimise errors and save time for your team, allowing them to focus on core business activities.
4. Invest in Employee Training and Development: Though training incurs upfront costs, it can be a long-term money-saver by enhancing productivity and reducing turnover. Utilize free or low-cost online courses and cross-training to upskill employees without excessive expense.
5. Optimize Employee Benefits: Choose cost-effective benefits that employees value, such as flexible working hours or additional paid time off, rather than costly perks. Regularly reviewing benefits can help tailor packages that align with business and employee needs.

By incorporating these strategies, small businesses can better manage employee costs, enhance their financial stability, and create a positive work environment that attracts and retains talent.

Compliance for small employers

Ensuring compliance with UK employment laws and tax regulations is critical for small business owners. Keeping up-to-date with requirements for PAYE (Pay As You Earn) and National Insurance Contributions (NICs) can prevent fines and penalties. One key aspect is making timely submissions to HMRC, which can be simplified using payroll software. Additionally, employers must adhere to regulations related to employee contracts, minimum wage laws, and statutory leave entitlements. Developing an understanding of compliance can be complex, so consulting with an accountant or using HR specialists can be an efficient way to navigate these requirements without adding significant overhead costs

Example cost breakdown for a small business

Consider a small business, such as a café, that employs two part-time employees at an annual salary of £15,000 each. In addition to the gross salaries, the business must pay employer NICs, estimated at approximately £1,000 per employee, and pension contributions of around £450 per employee. Operational costs include the necessary equipment, such as point-of-sale systems and safety gear, totaling £2,000 annually. Employee training costs, essential for maintaining quality, add another £500. Overall, the total annual employee cost per barista can reach £18,000–£20,000. By examining these figures, small businesses can better plan their budgets and identify areas where savings can be made without compromising employee satisfaction or service quality.

Invest in knowledge, save on costs

Understanding and managing employee costs is a cornerstone of financial stability for small businesses. Investing time in learning about hidden expenses, compliance, and efficient cost management strategies can pay off in the long run. 

Small business owners who take the initiative to streamline payroll, optimise benefits, and plan for unexpected expenses create a more sustainable business model. Getting professional advice from accountants and using cost-effective tools ensures that businesses remain competitive while protecting their financial health.