Can I Afford to Hire? Easy Method to Calculate Wage Cap

Author: Prosperity Bookkeeping LLC |

Blog by Prosperity Bookkeeping LLC

Help Wanted signs are everywhere! In almost every sector of the economy, companies are scrambling to find workers. In today’s tight labor market, job seekers are in the driver’s seat. The U.S. unemployment rate was just 3.6%-4% in early 2022. This equates to nearly two available jobs for every unemployed person. As a result, employers have to compete harder to attract and hire the talent they need to be fully staffed. One way to attract job seekers is to pay well.

A competitive salary:

  • Attracts ideal candidates for job openings
  • Shows that employers value employees and their productivity
  • Helps retain employees long-term, avoiding costly staff turnover
  • Boosts employee morale and job satisfaction
  • Builds positive word-of-mouth in the community and industry
  • Contributes to a company’s reputation as an employer that people want to work for

Hiring and retaining competent employees requires a solid Human Resources strategy. One piece of the employment puzzle is payroll. Determining employee wages is a balancing act. When setting employee wages, employers have to weigh several factors:

  • Employee expectations
  • Current market value for the position
  • Value the job candidate will bring to the business
  • What the employer can afford

Let’s focus our attention on the last bullet point. Calculating what’s affordable isn’t as complicated as you might think. Small business owners who calculate their wage cap know exactly how much to budget for payroll. As a consequence, they know whether they have the cash flow to retain the staff they have and maybe even hire new employees.

Use this 4-step process to calculate wage cap:

1. Determine your expected revenue. Hint: Revenue appears first on a company’s income statement.

2. Calculate non-payroll expenses. Hint: Common examples are office supplies, rent, interest payments, and utility costs. Plus, small businesses that sell products and services should include the cost of goods sold in non-payroll expenses.

3. Determine the profit you want to achieve. Hint: Healthy profit margins for small businesses tend to be 7-10%, depending on the size and the nature of the business.

4. Plug these three numbers into this Wage Cap formula:

Expected Revenue - Desired Profit - Non-payroll costs = Wage Cap

Here’s an example for XYZ Company, using $1M in revenue, a 10% profit of $100,000 and $400,000 in non-payroll costs.

$1,000,000 - $100,000 - $400,000 = $500,000.

Essentially, XYZ Company has $500,000 to spend on employee wages.

Knowing the cash available for payroll allows employers to budget accordingly. They can hire and employ part-time and full-time employees, as long as the sum of all W-2s doesn’t exceed $500,000. If the W-2s exceed $500,000, then it’s time to reduce the workforce. This may sound simple, but in reality, workforce reductions involve some tough decisions. By calculating wage cap, employers have a clear-cut formula to guide them.

Prosperity Bookkeeping offers small businesses the tools they need to reach their financial goals. For business advising and virtual bookkeeping services, contact us today.