Bringing on new employees is an exciting part of business growth. But if you haven’t done it before, or even if you have, it may be daunting to think about taking on the added responsibility. Can you afford the expense of a new hire? How do you navigate the administrative aspect of paying them? Maybe you’re only paying yourself thus far, and that’s simple enough—you just transfer fixed percentage allocations into your Profit and Owners accounts twice a month. That all changes when you have a team.
As you know, the Profit First system involves setting up five separate bank accounts for the distribution of funds. But there are smart reasons to create additional accounts, or subaccounts, to earmark and protect funds that need to be reserved for a certain purpose. Paying employees might be one of those reasons.
Split Payroll from OPEX?
That is why we often suggest that if you have any employees besides you as the owner, you should create a separate payroll account, as a subaccount of OPEX.
Why do you need a separate payroll account? Why can’t you just take from OPEX to pay your employees? Two big reasons.
A separate account makes sure the money you’ve allocated for employee wages can’t accidentally get intertwined with all your other expenses, and then accidentally spent. For example, if your rent and your payroll are both paid out of OPEX and one of these expenses would happen to place you in overdraft this month, the bank will decide what to pay. The bank might choose your rent over your payroll. They’re both important, but which is easier to rectify?
Having separate accounts ensures that your team members get paid no matter what. Bouncing a payroll check is really the absolute worst for employee morale.
Having the payroll account split from OPEX also ensures that you meet your obligation to set aside the taxes you owe to the federal government on behalf of your employees as soon as you pay their wages. These funds can’t get accidentally spent either. This is another big one. You don’t want to get in trouble with the IRS for failure to pay your payroll taxes.
And don’t let us scare you too much. Read our blog post on some common payroll mistakes and how to avoid them.
Can You Afford to Hire Help?
Theoretically, a new hire should help to generate revenue in some way, or free up the owner to do so, but in reality things can take a while to get off the ground—or things might not go according to plan. You need to onboard the new employee, which takes time. Time where they may be costing you time and money.
And according to Profit First principles, hiring an employee is a business expense that you must be able to meet without increasing your current total OPEX allocation. This means, for example, that if your current OPEX target allocation percentage is 50%, and your payroll subaccount target is determined to be 25%, then your OPEX becomes 25%.
So how do you determine what percentage to allocate toward the payroll subaccount?
If you’ve already got employees on the books, take a look at last year’s figures to see what you paid for employees in total. Determine what percent of your revenue that figure was, and use it as a basis for your payroll target allocation percentage.
If you’re considering your first hire, you will want to have one month’s worth of employee salary as a buffer in your payroll account before you bring them on board. Determine what that figure is, and then try to transfer 2-3% from OPEX into the payroll account each month until you’ve reached that figure.
The length of this process will enlighten you as to whether hiring someone now is feasible. Did it take just a month or two to accumulate that one-month salary buffer? Then you can probably afford to add that employee. On the other hand, did you struggle to make available 2% from OPEX each month to transfer to the payroll account? If that’s the case, you need to rethink your decision.
Independent Contractors… on Payroll?
Your business might depend on independent contractors, rather than employees. In terms of cash flow management, we recommend that you compensate them from your payroll banking account if they are providing your clients substantially the same service that is provided by your business as a whole (for example, personal trainers who are contractors at a fitness studio). If, however, the independent contractor is providing a service FOR your business, such as janitorial or marketing services, you should include this expense as part of OPEX.Here’s more on leveraging team members in your wellness business.