Evaluating the ROI of a New Employee for Your Small Business

August 1, 2019・6 mins read
Evaluating the ROI of a New Employee for Your Small Business

If you’re considering adding an additional employee to your team, you first want to determine whether or not such an investment will be fruitful. A successful hire can increase the efficiency of your daily operations and bring in new business for your company, but you must consider just how much you will have to spend to acquire them — especially if you’re considering business funding to cover the costs. The lengthy search and selection process will cost you and your existing team valuable time, resources, and money. Plus, once you finalize your decision and bring on a new employee, there will be training expenses on top of having to add an additional salary (plus benefits, health insurance, payroll tax, and all the other costs). Thus, it’s important to be selective in your decision making. Evaluating the ROI (return on investment) of a new employee is one method that can help you weigh the costs of your new hire against the potential benefits.

What is your ROI?

In determining your ROI, you are performing a cost-benefit analysis that will hopefully demonstrate a likelihood of return.

Step 1: Determine employee turnover rate

First, determine your turnover rate or the average rate at which employees leave your company (whether they are fired or they quit).

Turnover Rate = (# of Employees Who Have Left in the Past Year / Average # of Employees in Business) x 100

Step 2: Calculate the costs

As a general rule of thumb, the lower you can get your turnover rate, the better your employee ROI will be. Next, estimate how much it will cost you to hire a new employee. This cost should take into account:

  • The number of hours it will take to interview, hire, and train the employee
  • Future salary and benefits
  • Any training or other costs associated with onboarding

Step 3: Calculate the benefits

Next, you want to clearly delineate the duties of the role that you are trying to fill. This is essential to determining the benefit half of your cost-benefit equation. When you know exactly what the position will entail and what this new employee has the potential to improve at your company, you can better evaluate the implicit value of making the hire. Try asking yourself these questions:

  • Will they free up resources in a certain department that is backlogged by taking on work?
  • Will they fortify a department that is currently lacking?
  • Do they have a special skill set that you think will lead to an increase in revenue?

Answering these types of questions will also point you to whether or not the new employee will contribute to your business’ bottom line directly or indirectly. A direct earner is an employee whose role includes generating revenue for your company, directly. Calculating the benefit of a direct earner is relatively straightforward. Let’s say you’re planning to hire a new salesperson. First, you want to look at your sales targets. Use this measure to determine how much money you would, ideally, like this employee to bring in. Once you evaluate whether or not you think this new hire will be able to meet or exceed this number (looking at their past work experience and other factors), you can subtract the estimated cost of hiring them from the expected new revenue. An indirect earner entails a position that is not directly tied to making money for the company but their addition to the team might indirectly spur revenue generation by improving efficiency and helping business run more smoothly. Some examples of indirect earners are project managers, administrative roles, or customer service representatives. Evaluating the future benefit of this type of employee is slightly more difficult than direct earners because you’re likely considering more intangible benefits like time saved or improved customer satisfaction. To proceed with your cost-benefit analysis, circle back to the kinds of questions about the role that we mentioned earlier.

  • Will filling this role free up your own time or the time of a department in a way that will allow the company to take on more business?
  • Is this a role that is now essential to accommodate the growth that you’ve recently experienced?

If you have been feeling bogged down by administrative work, to the extent that you feel that it is taking away from your ability to give your clients adequate attention or to bring in new business, the value of hiring an office manager could very well be worth it. Here, the estimated benefit would include the amount of new business you think you could bring in if you had more time or the value of improved customer satisfaction (e.g. getting current clients to invest more money into your business), and you’d subtract the estimated cost of hiring from this number.

Step 4: Total the costs and benefits

Finally, sum your costs and benefits. If you end up with a positive number, then the hire is likely a solid investment in the human capital of your business. This is not to say that an estimated cost-benefit analysis is a foolproof way to evaluate a new hire: human is the key word here. As an employer, you know an employee’s ability to help or hurt the company goes beyond their ability to perform. Their work ethic, compatibility with other team members, and other personality traits are factors that could either positively or negatively contribute to their value as a hire, but these are nearly impossible to quantify. Nevertheless, a cost-benefit analysis method is a strong baseline for helping you make a decision that has the potential to be simultaneously very expensive and lucrative. Say you determine that the ROI of adding a particular new employee is high, but you simply do not have the capital on hand to offset the costs of hiring, training, and payroll. If this is an investment that you have determined will really help your business, you could consider taking out a form of business funding. From term loans to SBA loans, business financing can help you cover the initial costs of hiring and allow you to repay after your investment has begun to pay off.

This communication is for informational purposes only; it is not legal, tax or accounting advice; and is not an offer to sell, buy or procure insurance.

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