This is Part II of a series on “When Can I afford to Hire My Next Employee”.
If you haven’t already, I’d encourage you to read Part I before reading this one.
Okay, now that you’ve decided you do need to hire a staff member, let’s see how you can understand if you can actually afford to hire that person.
But, before we begin, a quick disclaimer.
This guide is for small businesses that are growing within some form of financial constraint. I mean to say that you don’t have a bottomless pit of investor’s money. If you are a funded tech startup, the principles will still apply. However, they are less applicable for founders in early revenue ventures that predominantly hire developers and product teams.
Rule 1: Forecasted Sales Cover at Least 2x Monthly Salary
Employees are assets. They may not be accounted for on your balance sheet, but they do add financial value to your business. If you let them.
Employees need time get up and running. They are not machines that are instantly productive with a flick of a switch. They need time to adjust into their role. The costs of this time, as well as the resources and energy to get there put constraints on your business.
The effort that your team spends training new hires could be otherwise spent generating revenue. The result is the costs of new hires can outweigh your revenue growth. This can create little or no profit. Or, at the worst-case scenario, create losses.
It’s important that you factor in enough revenue to not only cover the cost of the new employee, but the indirect costs of training and ramp-up time as well.
So what’s enough revenue? You want to ‘set aside’ at least two time the monthly salary cost of new, secured revenue in the same month that your new staff is hired. This revenue allows a buffer to cover the costs, plus some.
For example, if your new hire has a salary of $6,000 per month, you should have at least $12,000 (2x) of new committed sales. This revenue should already be sold before signing any employment contract.
The Waves of Hiring
The risk posed by not having enough revenue to support the cost of your new hires is that you ‘erode’ your profit — meaning that the costs incurred in employing each staff member outweighs any new sales generated. If this hiring cycle continues, you run the risk of growing revenue and employees with no profit.
You run the risk of creating a big, bloated inefficient business. A growing beast that swallows its own tail.
Hiring on ‘gut feel’ model
Having new revenue at least 2x the employee cost ensures that your business remains profitable with new hires. The result is that you grow revenue, employee headcount, and profit — all at the same time.
Hiring on ‘2x revenue model’
What if I’m Busting at the Seams with that Revenue?
Back in the day — when it came to hiring new staff — the gauge I used was how busy we were. If the team was up to their elbows with work and we were busting at the seams, it was time to hire another person. We’re all busy, so that means there’s room to grow, right?
Being ‘busy’ doesn’t mean you are being effective or productive. For example, your business could be delivering its product inefficiently, or burning too much time doing back-office admin. In this case, hiring more people will not result in fixing your underlying productivity issues. It will result in more headaches, more costs, and less profit.
If you feel the need to hire more staff and the new committed revenue is not there to support a new hire, there’s a bigger problem with your business.
That’s worth restating: if you ‘need’ to hire before you can afford, you have a different problem.
Maybe you’re not pricing your product or service correctly. Or it could be that you’re producing what you sell inefficiently. Remember, if you hire before you’re ready, you’ll only magnify whatever your true issue is. It’s okay; don’t stress out.
You can understand where the problem resides by calculating your revenue per employee metric. If it is below the benchmark you need — improve that metric first. Figure out what tweaks you can make in your business to increase the leverage of your staff. I offer some other tactics in a separate blog to help you with that.
Rule 2: Always Have 2 Months of Wages as Cash in the Bank
The difficulty with ‘making payroll’ is often due to late paying customers. Although your company might be profitable, the cash may not be available in your bank account. To protect yourself from this issue, have 2 months of your new employee’s payroll set aside in cash before you hire them.
Having this cash available protects yourself from 60 day accounts receivables.
Remember, it’s unlikely your new hire will be revenue and cash flow generating from day one. Having a buffer of cash in the bank protects yourself.
As business owners we can get caught up in the adrenaline of growth and expansion. Before you jump to conclusions on hiring staff, ask yourself — do I need more staff? And secondly, can I afford it?
Bigger doesn’t mean better.