The complete guide to calculating employee cost and value 

A few months from now, you might be holding your head in your hands wondering why the company’s operating income or capital took a hit.  

More often than never, the answer leads to employee costs! 

It’s normal for businesses to spend between 40% to 80% of their gross revenue on employees, and this is only for compensation, as per the US Bureau of Labor Statistics. With a large portion of company spend being on employees, it’s irrefutable that employee cost calculations must be nothing less than accurate.  

What makes it difficult to calculate employee costs, and where is there much confusion? 

The answer boils down to not accounting for all the crucial factors while calculating employee costs. These include: 

• Inaccurate time tracking  
• Turnover costs  
• Poor data collection  
• Lack of communication between HR and finance departments  
• Insufficient allocation of overhead expenses 

To get an accurate picture of employee costs, one effective way is to understand financial information. 

Why and how must HR use financial information  

HR is no longer viewed as only a people-oriented domain that has nothing to do with numbers or data. The department now performs broader functions outside its administrative role. However, HR still falls behind when it comes to leveraging the current data.  

With labor costs making up as much as 70% of total operating costs of a business, HR must be knowledgeable about finance since it plays an important role in bringing value through hiring and training employees. This is one of the key factors that differentiates HR as strategic partners, where its able to communicate financial information with one another. To get started with leveraging financial information, HR must: 

Understand the factors that drive costs and value: This helps HR make decisions that help meet the company’s cost budget and promote overall organizational goals. 

Work with the finance department: A company performs better when HR and finance departments join forces to maximize returns on employees. For instance, HR can work with finance to understand where and why the organization fails to meet the employee cost budgets while looking for any gaps. 

Analyze the financial records: Financial statements and records pave the way to making more data-driven decisions and understanding where to allocate resources and where to eliminate. This also helps determine which initiatives or plans provide the highest ROI. 

Combine data to drive business goals and facilitate action: Just gathering data is not enough. HR must approach the finance department after analyzing reports on employee costs and identify any missing gaps.  

For example, the reports may show that the costs of recruitment, training, and turnover are extremely high when compared to other expenses. One reason for such high costs could be due to poor work-life balance or less career development opportunities – ultimately leading to turnover. Both the departments can combine the data to generate reports and insights which can help the organization take informed decisions to improve the same. 

Move in the direction of KPIs: When presenting the proposal to the organization regarding the new budget plans to implement engagement or career development programs, HR must clearly articulate the benefits of investing in employees and how everything ties up to their respective KPIs like revenue, customer satisfaction, etc., to finance as well as the business leadership.  

 Once all sides are counted, the next step covers the actual calculation of employee costs. 

The 3-stage method to calculate employee costs 

Every HR professional has faced that moment: the leadership team asks for the “real cost” of employees, and despite years of experience, you hesitate. Traditional calculations focusing solely on salary and benefits feel incomplete, yet expanding beyond these basics often leads to scattered, inconsistent results. If you’ve ever presented employee costs only to have department heads point out forgotten expenses weeks later, you’re not alone. 

The 3-Stage Method for employee cost calculation offers a systematic, comprehensive approach that captures expenses throughout the complete employee journey. Unlike conventional methods that typically focus on direct compensation and benefits, this model provides a framework that ensures no cost falls through the cracks, from the moment you decide to hire until well after an employee’s departure. 

Pre-hire expenses: Setting the foundation 

The journey begins before your employee does. Pre-hire expenses encompass all costs incurred during the talent acquisition process, often overlooked in traditional calculations. This stage helps HR teams understand the true investment required to bring new talent onboard. 

Key components to consider: 

• Recruitment technology and platform subscriptions 
• Job posting fees across various platforms 
• Recruiter time and salary allocation 
• Assessment and testing costs 
• Interview process expenses (including interviewer time) 
• Background check and verification fees 
• Employer branding and recruitment marketing 
• Agency fees if applicable 
• Travel and accommodation for candidates 
• Sign-on bonuses and relocation packages 

For technical roles in IT or engineering, factor in technical assessment platform costs and specialized recruiter fees. Healthcare organizations should include licensing verification expenses and medical screening costs. For retail and hospitality, consider mass hiring event expenses and seasonal recruitment campaigns. 

Employee lifecycle costs: The main investment 

This stage represents the bulk of employee-related expenses, covering the period from day one until the last day of employment. It’s crucial for accurate budgeting and understanding the true cost of maintaining your workforce. 

Key components to consider: 

• Base salary and regular increases 
• Benefits package (health insurance, life insurance, disability) 
• Retirement contributions and matching 
• Payroll taxes and workers’ compensation 
• Training and development programs 
• Performance management systems 
• Equipment and technology provision 
• Workspace costs (office space, utilities, supplies) 
• Professional memberships and certifications 
• Regular health and safety compliance 
• Team building and employee engagement activities 
• Performance bonuses and incentives 
• Time off and paid leave 
• Insurance and liability coverage 

Manufacturing sectors should include safety equipment and specialized training costs. Technology companies need to factor in regular hardware upgrades and software licenses. Healthcare providers must consider ongoing medical certification and specialized insurance costs. Educational institutions should include curriculum development time and educational material costs. 

Post-exit costs: The often-forgotten final stage 

Post-exit costs can significantly impact on your bottom line but are frequently overlooked in traditional calculations. This stage helps organizations understand the full financial impact of employee departures and prepare accordingly. 

Key components to consider: 

• Exit interview time and administration 
• Severance packages 
• Continuation of benefits 
• Knowledge transfer and documentation time 
• Equipment recovery and processing 
• Access revocation and security measures 
• Legal review and compliance costs 
• Temporary coverage arrangements 
• Alumni program costs 
• Post-employment references administration 
• Unemployment insurance impacts 
• Final payroll processing and tax documentation 

Financial services should include extended compliance monitoring and client relationship transfer costs. Technology companies need to consider intellectual property protection measures. Healthcare organizations must factor in patient care transition costs and medical record access management. 

How to calculate the actual cost of an employee: The formula 

Calculate the basic salary of the employee. It is the compensation received in exchange for work but does not include any additions or deductions. Mandatory costs include any additional benefits to the employees like social security, medical care, insurance, etc. Overhead costs refer to utilities, rent, office supplies, and other expenses. Hiring costs may cover training expenses along with recruitment and onboarding costs. Overtime and sick costs refer to overtime payment and cost of replacements. The formula to calculate the cost of an employee is:  

Employee costs = Base salary + mandatory costs + hiring costs + overhead costs + overtime/sick costs  

Companies may choose to calculate employee costs on an individual basis, group, or department basis. The above formula can be applied when calculating per employee or per group.  

For example:  

• Base salary = $50,000  
• Mandatory costs = $6000  
• Hiring costs = $1000  
• Overhead costs = $8000  
• Overtime and sick costs = $3000  

 According to the formula:  

Employee costs = Base salary + mandatory costs + hiring costs + overhead costs + overtime/sick costs, the total employee costs would be $68,000 per year.  

Some companies prefer to group employee costs per year and then divide the total costs per variable by number of employees.   

Employee cost breakdown by department 

Employee costs are also largely influenced by departments. An employee hired in a sales department may cost the company more than an employee hired in the marketing department. For instance, an organization will have to consider incentives, commissions, and travel expenses apart from basic salaries and benefits for sales employees. Such costs could be higher than a marketing employee whose costs are associated with advertising and other campaigns. In addition to salaries and benefits, other department costs that also must be considered are: 

After identifying upskilling and departmental cost, the new employee cost formula can calculate the real cost of an employee.  

Employee costs = Base salary + Mandatory costs + Hiring costs + Overhead costs + Overtime/sick costs + Upskilling costs + Department costs 

Different ways to calculate employee value as per business type 

Employee value, or value of an employee, refers to the worth an employee brings to the organization. It could be in the form of revenue, performance, productivity, sales, etc., depending on the business. But they are not enough to give a complete picture of an employee’s value.   

There are several other factors organizations will have to consider like employee loyalty, goodwill, etc., which are important but difficult to quantify. There are many ways an organization calculates its value of employees. Some of the most used ones are: 

Companies with lower headcount  

 This method of calculation is heavily unreliable as it only shows the average number for all the employees but does not reveal the real value per employee. It is a misleading and oversimplified way of measuring the employees’ value.   

Employee value = The firm’s net income/number of employees   

However, this type of method is ideal when companies have very few employees and the profitability of the firm has been heavily dependent on the contributions of individual employees. In such cases, the businesses’ net income can be tied to the number of employees.  

Companies with a focus on cost management and those on thin profit margins  

 This is a simplified way to calculate employee costs. It doesn’t consider other qualitative factors, but this method of calculation is most ideal for companies with a focus on cost management or if they are running on thin profit margins. Employee assets refer to the skills, knowledge, and expertise the employees bring. If the assets outweigh the costs, it is said that they bring significant value to the company and if the costs outweigh the assets, the employee is considered a liability.  

Employee value = Employee costs – employee assets    

Company that’s past the survival stage 

While the below formula considers employee costs, it does not cover the true cost of an employee. This formula includes the current value an employee brings to the table, the potential to take on new and different challenges, and their emotional expensiveness. 

Employee value = Current performance + future potential – emotional expensiveness    

Emotional expensiveness refers to employees who bring down the energy, value, and talent of other employees and the organization by being judgmental, resisting change, etc. Such employees can be identified by methods like peer reviews, surveys, performance evaluations, etc., which must be further validated by other employees.  

Measuring employee value: A dual-sided approach 

Most companies do not take a holistic approach when it comes to measuring and improving the worth an employee brings to the company. They solely focus on short-term financial gains, leading them to ignore the qualitative, or the ‘perceptual’ side, of employee value measurement. To take a more balanced method, organizations must consider the two sides:  

• The data-driven side  
• The perceptual side 

The Data-Driven Side  

As the name implies, the data-driven side is more of a financial metric most organizations use to measure their employee value. This involves gathering quantifiable data related to the performance, skills, and productivity of an employee. Some of the methods used to calculate the value of an employee are:  

Revenue Per Employee (RPE): This metric is used to calculate the revenue generated per employee. The formula to calculate is   

RPE = Company revenue/Number of full-time employees 

It is mostly used by service-based industries that rely heavily on their employees to generate revenue. And it is used by product-based companies to identify areas to improve. This method is also often used by investors and analysts to compare profitability between companies.  

Net Promoter Score (NPS): NPS is not a direct method of measuring employee value but can be used to quantify an employee’s contribution to customer satisfaction. This method is most suitable when there are specific employees responsible for customer interactions or product development.   

= % of promoters (score of 9-10) – % of detractors (score of 0-6)  

Return on Investment (ROI): ROI calculates the value generated by an employee after investing in their training, development, compensation, etc. Total cost refers to the employee costs and total benefits refers to increased sales, cost savings, profits, etc., contributed by an employee.  

= (Total cost – total benefits)/Total cost  

Employee Lifetime Value (ELTV): ELTV measures the value an employee brings over the course of their employment cycle. It takes into account their present and future contributions to the company.   

= Positive value an employee brings – total annual employee cost  

Performance reviews and OKRs: Certain metrics are used in performance reviews and OKRs to measure the value of an employee. If employees are meeting their objectives, they are said to be delivering significant value to the company. These are relatively easy to quantify. Companies like Google use OKRs and performance reviews to quantify their employees’ value.   

The Perceptual Side  

The data-driven side is not enough to determine the value of an employee. There are other intangible factors that give a holistic view of employee value measurement. This may also include non-financial metrics. Perceptual can also be referred to as the qualitative or soft side. The perceptual side includes:  

• Skills assessments   
• Leadership, decision-making, and teamwork  
• Future potential  
• Emotional expensiveness  
• Innovation, ideas, and engagement  
• Initiative taking  
• Loyalty   
• Customer satisfaction  
• 360-degree feedback  

The perceptual side is measured via surveys, focus groups, interviews, and performance reviews. They cannot be relied upon completely as they are subjective and influenced by various external factors. A balance of both data-driven and perceptual approaches gives a complete picture of employee value.  

For example, an employee may deliver high profits (data-driven metric) but if they are emotionally expensive (qualitative factor) and affect the productivity of others, their overall value to the company may be lower than another employee who generates lower profits but is not emotionally expensive. 

HR’s strategic role in leveraging employee value 

The Employee Value Equation is used to measure the value of an employee by estimating their current and future potential. It is used to maximize human potential by combining both quantitative and qualitative factors. With HR’s evolving roles, business leaders often wonder:  

Can HR only be labeled as a ‘cost-center’, or can they really step up their game to transform into a profit center?  

In fact, HR has always been contributing to the revenue, and organizations are just beginning to identify the value they provide through management of employee retention, talent, productivity, etc. They do this by leveraging the value of employees. They do it by:  

Capitalizing on the qualities that matter: HR can work with managers to redefine KPIs that include innovation, leadership, and other factors along with customer satisfaction ratings and other numbers. It can also help build a culture of recognition and rewards for meeting their newly defined KPIs. By working closely with managers, HR can help in leveraging the value of employees and drive success through feedback, coaching, and development opportunities.  

Going beyond OKRs and performance reviews: When the right employee is not put in the right position, it reduces value and productivity. HR can see beyond OKRs and performance evaluations and can place talent in the right place. Individual success is maximized, and value is increased.  

Encouraging HR and finance to work as business partners: Enable transparency among employee costs, skills, and strategy. Consider investing in a system that integrates finance and HR to manage workforce and plan performance. This integration helps understand the relationship between employee revenue drivers and other triggers to help connect the workforce with strategic goals. Data transparency is required across all areas of the business.   

Connecting HR with data, systems, and finance: Revenue generation usually begins with the sales department, but most companies end there. Most organizations wouldn’t expect HR to assist in this process through employee data alone. Apart from performing its traditional role, HR can exploit the myriads of employee data to understand what drives sales conversion rates. This requires access to the sales data of target employees.   

After understanding the drivers/triggers, HR can improve the operating units that prevent employees from participating and sustaining their performance. This connects employee data with business outcomes while also fostering a business relationship between Human Resources and business development leaders.  

For example, when the HR team at Adobe Systems realized that the performance review system, which relied on a standard ranking and rating system, was forcing employees to resign, they eliminated the annual review system.   

Employees would be rated only once a year and no more than 15% of a team can be rated as a ‘high performer’. In addition, the ratings determined the compensation and promotional decisions. Employees couldn’t figure a way out of the system and realizing that their efforts weren’t counted, they chose to leave. Every year during the review period, the productivity levels were very low and after that period, the attrition rate rose sharply.  

Donna Morris, the VP of HR, conducted internal surveys and interviews to properly understand the problem. The company then introduced a new compensation and reward system along with frequent feedback. In fact, it also adjusts its compensation plans every year. The outcome is increased morale and a 30% decrease in voluntary turnover.   

While the outcome is positive, it’s important to note that behind the scenes HR had access to a variety of data to understand the triggers of such low unproductivity and turnover. It also worked with the finance team to assess the costs and benefits of successfully implementing the new reward and compensation system. The collaboration between these two departments played a critical role in ensuring the success of the project. 

Putting the pieces together 

It has always been a challenge to manage the workforce throughout the employee life cycle – especially the modern workforce. A system is essential to collect the data from HR metrics. It is essential to identify areas of improvement to drive business outcomes. HR Analytics is a solution to Human Resources that provides data to enhance practices and improve employee experience.   

 Keka’s HR Analytics software helps take data-driven decisions by providing insights into each department’s workforce, generating instant reports, compensation and attrition analytics, and many more.