You care about your team and want to support them through the cost of living crisis. If money were no object, you’d increase their salaries tomorrow. Unfortunately, it’s not the reality. Your business is also having to tighten the purse strings as it deals with rising costs, and there are various factors to bear in mind when considering if you can afford to increase staff salaries. Should I increase my employees’ salaries to help with the cost of living? – let’s explore this in more detail.
Think about how different employees are affected.
The cost of living crisis doesn’t have a one-size-fits-all impact. The different types of workers you employ are likely to influence how their day-to-day is being affected. For example, for a professional employee on a mid-level salary, the crisis could mean they’ll be taking one holiday a year rather than two. On the other hand, an “unskilled” worker on a lower salary could be having to choose between heating their house and putting food on the table. Salary increases will be felt at different levels by different team members, so examine where it could make the most impact.
Calculate what your business can really afford.
Do you have a good understanding of the costs involved in operating your business? A clear overview of exactly what’s coming in and out of your business is fundamental to working out whether you can afford a pay rise.
How much have your non-employee costs increased by? Have you passed on these costs to your customers by raising the price of your products or services? If the answer’s no, it could mean you’re taking a hit on your profits. With prices likely to continue to rise, you need to think about how long your business can keep absorbing these costs.
Let’s put this into context by looking at how an increase in employee costs could impact your profit margin:
| Baseline | Increase | Revised | |
| Sales | £20,000 | 8% | £21,600 |
| Cost of sales | |||
| Employee costs | £5,000 | 4% | £5,200 |
| Other direct costs | £10,000 | 10% | £11,000 |
| Gross profit margin | £5,000 | £5,400 | |
| 25% | 25% |
In this scenario, you’re raising your prices by 8% and your non-employee costs have increased by 10%. In order to continue maintaining your percentage profit margin you can afford to increase employee costs 4%.
Remember: employee costs aren’t just made up of wages and salary.
When calculating how much you can afford to increase employee costs by, don’t forget that it’s not just the increase to base costs that you need to consider but also the impact on employer national insurance and pension costs (if applicable). These also need to be factored in on the higher cost base.
What this looks like in context:
| Baseline | Increase | Revised | |
| Sales | £20,000 | 8% | £21,600 |
| Cost of sales | |||
| Employee costs | £5,000 | 8% | £5,400 |
| Other direct costs | £10,000 | 10% | £11,000 |
| Gross profit margin | £5,000 | £5,200 | |
| 25% | 24% |
In this scenario, you’re increasing your employee costs at a higher rate (8% rather than 4%), but you’re still only raising your prices by 8%. Whilst the percentage of your gross profit margin has decreased, your absolute gross profit margin has still increased. On the face of it, the increase looks like good news, but you may find that your breakeven sales have increased (not such good news!)
Let’s develop the above example a bit further.
| Baseline | Increase | Revised | |
| Sales | £20,000 | 8% | £21,600 |
| Employee costs | £5,000 | 8% | £5,400 |
| Other direct costs | £10,000 | 10% | £11,000 |
| Gross profit margin | £5,000 | £5,200 | |
| 25% | 24% | ||
| Overhead costs | |||
| Other overheads | £2,000 | 10% | £2,200 |
| Employee costs | £1,000 | 8% | £1,080 |
| Net profit | £2,000 | -4% | £1,920 |
You can see that in the above example, although our gross profit margin has increased in absolute terms, it hasn’t increased by enough to cover the overhead increases and this has caused a decline in net profit.
Let’s now look at what these changes mean for the breakeven sales position.
| Baseline | Increase | Revised | |
| Overheads (other overheads + employee overhead costs) | £3,000 | 9.3% | £3,280 |
| Gross margin % | 25% | 24% | |
| Breakeven sales (overheads / gross margin %) | £12,000 | 13.9% | £13,667 |
| Check breakeven | |||
| Sales | £12,000 | £13,667 | |
| Gross margin % | 25% | 24% | |
| Gross margin | £3,000 | £3,280 | |
| Overheads | £3,000 | £3,280 | |
| Net profit | £0 | £0 |
From the above, we can see that the small decline in the gross margin percentage, combined with the increases in overhead costs, has caused the breakeven sales number to rise by almost 14%.
Be aware of the effects on staff retention.
With rising inflation resulting in higher costs of everyday items, your staff will feel the pinch if their salary stays the same – or increases at a rate that’s below inflation. It means a real-terms pay cut. No matter how much they love their job, loyalty will only go so far if your employees are struggling to make ends meet.
What are your competitors doing? If you aren’t matching their salaries, retention could become an issue. If your staff leave your business for one offering better pay, this increased turnover will take its toll on your cash flow. Recruitment, training and onboarding are extra costs to consider. If they stay, could motivation become a problem so productivity takes a hit? Weigh up the repercussions of maintaining pay at its current level and whether this could actually cause greater strain on your finances down the line.
Explore non-salaried ways to provide support.
There are a multitude of ways to ease the strain of the cost of living that aren’t tied to salary. Check out our blog that dives into ways you can help your team without permanently pushing up your monthly employee costs.
Get support to make a decision that’s right for your business.
As you can see, there are lots of issues to consider when asking yourself ‘Should I increase my employees’ salaries to help with the cost of living?’
There are a lot of factors to consider when making those big business decisions, and sometimes you just need a sounding board for peace of mind. That’s where One Accounting comes in. We work in partnership with established business owners, offering strategic support for moments like this. We’re the partner in your corner, helping you make smart decisions that drive your business forward. Fill in our form and let’s look at giving your business the support it deserves.
