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Modernize the Way You Forecast Headcount & Payroll Expenses

Like most organizations, labor costs represent a large majority of total spend - as much as 70% in some industries.  This includes gross wages, employer taxes (federal and state) as well as benefits (such as insurance and 401k).  Given the significance of labor costs to an organization, it’s quite surprising that many budget owner's project labor costs using a simple gross pay multiple (1.1x - 1.3x of gross salary/wages). While this simple, shortcut method may suffice in crunch times or for an organization that has a small headcount, the discrepancies that exist for actual versus projected labor costs become extremely material as headcount and an organization grows.

What’s even more surprising is the fact that although estimating employer payroll tax liability may seem like a black box, the data that’s needed is actually publicly available.  Federal Medicare and social security tax rates are available, as well as the wage caps and surplus tax rates. Even more, state unemployment insurance tax rates (and administrative fund fees, if applicable) are also widely available - oftentimes compiled on a tax site. 

After experiencing the pain points of projecting payroll spend ourselves at Trace, we started to dig deeper to determine what could be done to project our payroll spend on a more granular level. After compiling employer tax liability rates on a state and federal level, we created a payroll spend model that eliminates the ambiguity of payroll budgeting.  Not only do we use this model internally, but we wanted to give it free to our Mobilize community to help finance teams manage their budgets on a more accurate level.  


Components of Employer Payroll Costs

First, let’s break down what actually goes into employer payroll costs:

1. Federal Taxes: The three federal tax components of employer payroll costs are:
  • Medicare Tax (FICA): 1.45% of wages up to $200k, 0.9% thereafter;
  • Social Security Tax (FICA): 6.2% of wages up to $132,900, 0% thereafter;
  • Federal Unemployment Insurance Tax (FUTA): 6% of wages up to $7k, 0% thereafter.
2. State Taxes: While state tax components vary by state, it’s typically only:
  • State Unemployment Insurance Tax (SUTA): The SUTA tax rate is almost entirely dependent on the length of time that your company has paid wages to a resident of that corresponding state. Companies that have paid wages in a state for a short period of time will likely have a higher SUTA rate when compared to a company that has paid wages in that state longer. It’s common that annually, SUTA rates are revised and updated.
  • Administrative Fund Tax: While the majority of states do not have Administrative Fund Taxes, this cost is almost always a fraction of the SUTA rate and usually combined in the total rate compiled on tax sites for each state.
3. Employee Benefits: While employee benefits differ by company offerings and plans, the material benefits include:
  • Medical, Dental and Vision Insurance: This amount varies by employee and is highly dependent on the type of plan or coverage your company offers. We’ve found that using an average cost per-employee per-month was a near accurate metric to use as an input. The actual cost will depend on the type of plan an employee chooses (single or family) as well as their election of out-of-pocket expenses.
  • 401k Employer-Match Contributions: Nearly 90 percent of companies offer traditional 401(k) plans for their employees and 76 percent provide employer-matching.  This illustrates that not only are 401k plans crucially important to help employees plan for their future, it’s also a material cost to employers. While predicting human behavior (i.e. who will contribute to their 401k and at what rate) is difficult, making a few assumptions to estimate a reasonable incremental contribution cost per employee is both straightforward and extremely value-add. 
  • Other Benefits: Some companies offer meal vouchers, transit benefits, or other incremental employee costs. These typically are a hard dollar value per employee and can be forecasted with great accuracy when broken down to a singular line item.


Gather Current Employee & Expected Hire Data

Next, identify what information is needed for your current employees and expected hires.

Basic Information:
  1. First & Last Name
  2. Title
  3. Department
  4. Employee location (This is applicable to the SUTA calculation as each state has a varying Unemployment Insurance tax rate)
  5. Employee type (Full-Time, Contractor)
Pay Information: 
  1. Pay Amount
  2. Pay Type (Salary, Monthly)
  3. Employment Start & End Date
  4. Cost Center Location (Where will you assign an employee's cost to?)
Benefit Information:
  1. Will they receive medical, dental and vision insurance?
  2. Will they contribute to their 401(k)? 


Getting Your Payroll Provider and Payroll Model to Communicate

The free payroll model we created relies entirely on manual inputs related to headcount, pay, department and other inputs aforementioned above.  While extremely valuable in and of itself, for companies with a large headcount and constantly changing pay (due to raises, promotions, etc.), we realized this can create room for error.

In response to this, we modified our internal payroll model to layer on current employee payroll expense on top of projected payroll expense. The idea is to generate a current-employee payroll report from your payroll provider. At Trace, we use Zenefits’ Business Intelligence application that allows us to generate a custom payroll report containing only the fields we need (pay, employee type, department, etc.). We then feed this report into our payroll model, which is then used as the foundation of our payroll expense projection. The model then uses our manual, forecasted hire projections to layer on top of our existing payroll expense to calculate a total forecasted payroll expense. 


Benefits From Granular Payroll Forecasting?

Aside from the obvious (more accurate spend projections) what are a few overlooked benefits of more accurate payroll spend projections?

  1. Provide C-Suite level executives with a clearer, more accurate picture relating to the runway they have with their current cash and financing projections. Depending on the amount of labor costs to an organization, more accurate payroll projections can lead to a 5-10% improvement in planning accuracy - which can yield millions in accuracy depending on the cash balance your company is working with.
  1. Help budget owners better manage their spend and stay within budget, meeting or exceeding goals set from the top-down. 
  1. Help hiring managers illuminate the true cost of an employee or potential hire.
  1. Free up budget spend for other cost items, such as a software subscription that will improve employee efficiency or additional employee benefits that will aid in the attraction of top talent.


Controlling and Understanding Your Costs

At Trace, we understand from firsthand experience that both understanding and controlling your organization's costs are crucial to its financial health and longevity.  Whether your organization is going through a massive restructuring (See Restructuring or not, keep your house in order), wanting to have more transparency, clarity and control over purchase requests, approvals and managements (See Trace Platform), or wanting to project your payroll spend more accurately, we strive to provide finance teams with the tools and resources they need to be successful and meet their financial goals.

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Like most organizations, labor costs represent a large majority of total spend - as much as 70% in some industries.  This includes gross wages, employer taxes (federal and state) as well as benefits (such as insurance and 401k).  Given the significance of labor costs to an organization, it’s quite surprising that many budget owner's project labor costs using a simple gross pay multiple (1.1x - 1.3x of gross salary/wages). While this simple, shortcut method may suffice in crunch times or for an organization that has a small headcount, the discrepancies that exist for actual versus projected labor costs become extremely material as headcount and an organization grows.

What’s even more surprising is the fact that although estimating employer payroll tax liability may seem like a black box, the data that’s needed is actually publicly available.  Federal Medicare and social security tax rates are available, as well as the wage caps and surplus tax rates. Even more, state unemployment insurance tax rates (and administrative fund fees, if applicable) are also widely available - oftentimes compiled on a tax site. 

After experiencing the pain points of projecting payroll spend ourselves at Trace, we started to dig deeper to determine what could be done to project our payroll spend on a more granular level. After compiling employer tax liability rates on a state and federal level, we created a payroll spend model that eliminates the ambiguity of payroll budgeting.  Not only do we use this model internally, but we wanted to give it free to our Mobilize community to help finance teams manage their budgets on a more accurate level.  


Components of Employer Payroll Costs

First, let’s break down what actually goes into employer payroll costs:

1. Federal Taxes: The three federal tax components of employer payroll costs are:
  • Medicare Tax (FICA): 1.45% of wages up to $200k, 0.9% thereafter;
  • Social Security Tax (FICA): 6.2% of wages up to $132,900, 0% thereafter;
  • Federal Unemployment Insurance Tax (FUTA): 6% of wages up to $7k, 0% thereafter.
2. State Taxes: While state tax components vary by state, it’s typically only:
  • State Unemployment Insurance Tax (SUTA): The SUTA tax rate is almost entirely dependent on the length of time that your company has paid wages to a resident of that corresponding state. Companies that have paid wages in a state for a short period of time will likely have a higher SUTA rate when compared to a company that has paid wages in that state longer. It’s common that annually, SUTA rates are revised and updated.
  • Administrative Fund Tax: While the majority of states do not have Administrative Fund Taxes, this cost is almost always a fraction of the SUTA rate and usually combined in the total rate compiled on tax sites for each state.
3. Employee Benefits: While employee benefits differ by company offerings and plans, the material benefits include:
  • Medical, Dental and Vision Insurance: This amount varies by employee and is highly dependent on the type of plan or coverage your company offers. We’ve found that using an average cost per-employee per-month was a near accurate metric to use as an input. The actual cost will depend on the type of plan an employee chooses (single or family) as well as their election of out-of-pocket expenses.
  • 401k Employer-Match Contributions: Nearly 90 percent of companies offer traditional 401(k) plans for their employees and 76 percent provide employer-matching.  This illustrates that not only are 401k plans crucially important to help employees plan for their future, it’s also a material cost to employers. While predicting human behavior (i.e. who will contribute to their 401k and at what rate) is difficult, making a few assumptions to estimate a reasonable incremental contribution cost per employee is both straightforward and extremely value-add. 
  • Other Benefits: Some companies offer meal vouchers, transit benefits, or other incremental employee costs. These typically are a hard dollar value per employee and can be forecasted with great accuracy when broken down to a singular line item.


Gather Current Employee & Expected Hire Data

Next, identify what information is needed for your current employees and expected hires.

Basic Information:
  1. First & Last Name
  2. Title
  3. Department
  4. Employee location (This is applicable to the SUTA calculation as each state has a varying Unemployment Insurance tax rate)
  5. Employee type (Full-Time, Contractor)
Pay Information: 
  1. Pay Amount
  2. Pay Type (Salary, Monthly)
  3. Employment Start & End Date
  4. Cost Center Location (Where will you assign an employee's cost to?)
Benefit Information:
  1. Will they receive medical, dental and vision insurance?
  2. Will they contribute to their 401(k)? 


Getting Your Payroll Provider and Payroll Model to Communicate

The free payroll model we created relies entirely on manual inputs related to headcount, pay, department and other inputs aforementioned above.  While extremely valuable in and of itself, for companies with a large headcount and constantly changing pay (due to raises, promotions, etc.), we realized this can create room for error.

In response to this, we modified our internal payroll model to layer on current employee payroll expense on top of projected payroll expense. The idea is to generate a current-employee payroll report from your payroll provider. At Trace, we use Zenefits’ Business Intelligence application that allows us to generate a custom payroll report containing only the fields we need (pay, employee type, department, etc.). We then feed this report into our payroll model, which is then used as the foundation of our payroll expense projection. The model then uses our manual, forecasted hire projections to layer on top of our existing payroll expense to calculate a total forecasted payroll expense. 


Benefits From Granular Payroll Forecasting?

Aside from the obvious (more accurate spend projections) what are a few overlooked benefits of more accurate payroll spend projections?

  1. Provide C-Suite level executives with a clearer, more accurate picture relating to the runway they have with their current cash and financing projections. Depending on the amount of labor costs to an organization, more accurate payroll projections can lead to a 5-10% improvement in planning accuracy - which can yield millions in accuracy depending on the cash balance your company is working with.
  1. Help budget owners better manage their spend and stay within budget, meeting or exceeding goals set from the top-down. 
  1. Help hiring managers illuminate the true cost of an employee or potential hire.
  1. Free up budget spend for other cost items, such as a software subscription that will improve employee efficiency or additional employee benefits that will aid in the attraction of top talent.


Controlling and Understanding Your Costs

At Trace, we understand from firsthand experience that both understanding and controlling your organization's costs are crucial to its financial health and longevity.  Whether your organization is going through a massive restructuring (See Restructuring or not, keep your house in order), wanting to have more transparency, clarity and control over purchase requests, approvals and managements (See Trace Platform), or wanting to project your payroll spend more accurately, we strive to provide finance teams with the tools and resources they need to be successful and meet their financial goals.

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