How to Plan for Hourly Employees in Your Budget

What is an hourly employee?

An hourly employee is paid a predetermined rate for each hour they work. The business may pay them weekly, biweekly, semimonthly or monthly. Since their hours worked during a pay period can vary, their pay will also vary.

According to Shelly Abril, senior payroll compliance officer at Gusto, “Under the Fair Labor Standards Act (FLSA), employees are classified as either exempt (salaried) or nonexempt (hourly) workers. While exempt employees are typically paid a fixed salary for their services regardless of the number of hours they work, nonexempt employees are usually paid an hourly wage based on the number of hours they work at an agreed-upon hourly rate.”

State and federal laws require employers to pay hourly employees a minimum wage. While wage requirements vary by state, employers must pay the state or federal minimum wage — whichever is higher.

Businesses may rely on paper time cards or digital employee time-tracking methods like time clocks to account for these employees’ hours worked. The employer must approve all hours worked before payment can be processed.

How do you budget annually for hourly employees?

The amount of time an hourly employee works may vary, so their pay often fluctuates. This uncertainty makes budgeting for hourly employees challenging, especially as a business grows.

Still, creating a payroll budget for hourly employees is crucial; it helps you better understand workforce costs and staffing requirements. Here’s how to get started making a payroll budget for hourly workers:

1. Create a list of all employees in the organization.

List all the workers you employ, including every full- and part-time employee. If you routinely hire temporary workers and utilize 1099 contractors and freelancers, include these individuals as well.

Even if a worker does not receive a paycheck weekly, you should still include them in your budget breakdown.

2. Calculate the total cost for each employee.

Abril advises creating a detailed budget with your total actual labor costs. “After you have listed all workers, including full-time, part-time, and temporary staff, calculate total costs for each employee, including wages, taxes, benefits and overhead. Divide the total costs by actual hours worked for an accurate hourly rate,” she said.

Remember to account for discretionary bonuses, retirement matches, overtime and any additional staff you intend to hire in your calculations. Furthermore, be sure to add the company’s financial responsibilities to each employee, including health care contributions and taxes (more on calculating hourly employees’ earnings below).

3. Review your results and note your total workforce cost.

Review the results of your calculations. You should be able to see the number of employees on your payroll and the total cost of your workforce.

To verify and stay on top of your total workforce cost, do the following:

• Run a payroll report before every pay period. Run a payroll report and check for errors. It is also crucial to proactively identify swings in totals (both low and high) so you can adjust spending in other areas if necessary.
• Process your payroll properly. Ensure your payroll runs account for wages, payroll taxes, benefits (health, life, retirement) and any miscellaneous expenses.
• Set overtime caps for your team. Abril suggests another strategy for managing payroll expenses. It’s to “determine a daily or weekly limit on overtime hours per employee that your business can afford. This helps distribute work evenly and control costs.”

If you’re looking to simplify your workload, you may want to consider using a payroll software. Consider our guide to the best payroll software, which can streamline even complex payroll operations for small businesses.

How do you calculate hourly employees’ earnings?

You calculate hourly employees’ earnings through the following process:

1. Calculate the hourly employee’s gross wages.
2. Deduct any tax requirements and voluntary and involuntary deductions.
3. Add back any business-related reimbursements.

Here’s a breakdown of each step:

1. Calculate the hourly employee’s gross wages.

To calculate gross wages for hourly employees, multiply the number of hours they worked by their hourly pay rate. For example, if your employee makes $15 per hour and completed 35 hours in a week, their gross pay calculation would be as follows:

35 (number of hours worked) x $15 (hourly pay rate) = $525 (gross pay)

When calculating gross wages, keep in mind that commission, overtime and tips will increase the final total. For example, if the same employee works 45 hours in one week, they’d be entitled to five hours of overtime at time and a half (more on overtime for hourly employees below).

This would be the pay calculation:

40 (number of hours worked) x $15 (hourly pay rate) + 5 (number of overtime hours) x $22.50 (overtime pay rate) = $712.50

2. Deduct tax requirements and voluntary and involuntary deductions.

Employers can withdraw money directly from an employee’s paycheck to cover benefits. Employees who elect these paycheck withholdings can lower their taxable wages, reducing the amount they owe for federal income taxes.

Pretax withholdings can include the following:

• Retirement contributions
• Health care
• Child care

Employee taxes include the following:

• Social Security tax
• Medicare tax
• Federal unemployment tax
• State unemployment tax (SUTA)
• Local income tax

Voluntary and involuntary deductions include the following:

• Child support
• Wage garnishments (including court-ordered)
• Uniforms or tools
• Tuition or certification
• Health insurance premiums

3. Add back business-related expense reimbursements.

Expense reimbursements include the following:

• Mileage
• Food

How does overtime pay work for hourly employees?

Hourly employees are considered nonexempt and are entitled to overtime pay if they work over 40 hours weekly. “Nonexempt employees are generally eligible for overtime pay, usually at a rate of at least 1.5 times their regular hourly rate beyond 40 hours in a workweek, according to the FLSA. They can also be eligible for benefits like health insurance and paid time off, but this depends on their employer and specific situation,” Abril said.

When are hourly employees entitled to overtime?

Once an hourly employee passes 40 hours in a workweek, they are entitled to overtime pay. Every hour worked after that is considered overtime, meaning employers must pay more per hour by law.

The workweek can start on any day of the week as long as it is consistently calculated. The FLSA defines the workweek as a “fixed and regularly recurring period of 168 hours — seven consecutive 24-hour periods.”

How much is overtime pay?

Overtime pay is generally 1.5 times the employee’s regular pay. For example, let’s say an employee makes $12 an hour and works 45 hours in one week. The employee would receive $12 an hour for the first 40 hours and $18 an hour for the remaining five. So, instead of making $540 for 45 hours, the employee would earn $570.

What about hospitals and residential care facilities?

Things work a little differently for hourly employees of hospitals and residential care facilities. The FLSA has a special provision called the “8/80 rule” that applies specifically to hospitals and residential care facilities. This rule allows these employers to calculate overtime based on a 14-day period instead of the standard seven-day period. Overtime is paid for hours worked over 8 in a day or 80 in the 14-day period — whichever is greater.

For example, a nurse might work 35 hours one week and 45 hours the next for a total of 80 hours. The nurse would not be paid overtime for additional hours in the second week because the total number of hours averages no more than 40 hours per week.

The 14-consecutive-days rule benefits those in the medical field who desire a flexible schedule or prefer to work for multiple facilities.

Do exempt employees receive overtime?

Exempt employees do not receive overtime pay. In this case, the employees are highly compensated for their work and overtime hours are excepted.

Sometimes, an employer provides additional financial compensation for exempt employees. The law limits compensation options. But, it may include a flat amount, a percentage bonus, or extra paid or unpaid time off.

Exempt employees include truck drivers, taxi drivers and salespeople.

Do hourly employees receive benefits?

Hourly employees who work at least 30 hours weekly may receive employee benefits, including health insurance, paid time off (PTO), life insurance, 401(k) retirement plans and employee bonuses. However, it’s common for hourly employees’ benefits to be less comprehensive than those of salaried employees.

Additionally, companies may require hourly employees to complete a specific number of hours before receiving benefits. This trial period ensures ample training and incentivizes the employee to perform well.

Should you hire hourly employees or salaried employees?

While hourly workers are paid for time logged, salaried workers receive a set compensation package unaffected by hours. Business owners must weigh the pros and cons of hourly and salaried employees to determine the best fit for their company.

Alajian sums up the differences between the two: “Salaried workers get paid whether they work or not. It’s a fixed cost commitment. Hourly worker time is flexible and can be determined based on need, and they get paid based on how many hours they work. But, they can also get overtime, whereas salaried employees largely don’t get that benefit.”

Pros and Cons of Hourly Employees

Depending on your business needs, hourly employees may make financial sense.

Some pros of hourly employees include the following:

• Control payroll: Hourly employees are closely monitored for the hours they work. If an hourly worker stays at or below 40 hours every week, you won’t have to give them any additional pay. Hourly employees make it easier to control employee hours and the amount of payroll going out.
• Help match labor costs to business needs: You can schedule your hourly employees to fit your business’s needs and hours of operation. For example, if you’re a retail or service business with set hours, you can create flexible schedules with set days or hours for each employee.
• Helpful for holiday rushes: Hiring hourly workers makes sense if your business is typically busy during holiday seasons — as long as your increased profits can offset additional labor costs. Hourly workers are more likely to work during holidays when an incentivized paycheck is available.
• Gain flexibility: Hourly workers may appreciate the flexibility of choosing their own hours and maintaining a positive work-life balance.

“For roles in customer service or in industries like retail and hospitality, being able to adjust schedules is important, especially to meet demand during busier times or to scale down at quieter times for more seasonal businesses,” Abril said. “Another advantage is the ability to provide a clear compensation structure so that employees know exactly how much they earn based on the number of hours worked.”

However, hiring hourly workers has its downsides, including the following:

• Can incur massive overtime costs: If you are frequently shorthanded or have a boom in business, paying hourly employees overtime (time and a half or double time) can add up quickly.
• May require various pay rates: Different tasks may require different pay rates. If an hourly employee performs duties that span various pay rates, payroll can get complicated.
• More likely to quit: If business is slow and workers aren’t receiving enough hours, they may not qualify for benefits. This may cause rapid employee turnover as they seek a more solid position.

Pros and Cons of Salaried Employees

Salaried employees receive a flat rate each week, no matter how many hours are necessary to complete their duties.

Some pros of salaried employees include the following:

• Ensure fixed payroll costs: Salaried workers simplify payroll processing because payroll runs will have little variation.
• Can save you money: Fixed weekly working hours come in handy if you regularly need your team to go the extra mile to handle issues and responsibilities. You won’t have to pay overtime for this occasional extra work.
• Make sense for 24/7 businesses: Salaried employees are also helpful if your business does not have set hours and you need employees on call 24/7. Salaried workers don’t need to track their working hours. So, if any issues arise, they can fill the gaps without depleting your financial resources.

However, there are a few downsides to salaried workers, including the following:

• Tracking salaried employees’ performance can be challenging: Salaried workers are paid even when they can’t come to work or have an appointment. For this reason, tracking each employee’s hours and performance can be difficult. It’s hard to weed out salaried employees who abuse their freedom and celebrate those who work more than required.
• Can be expensive: The costs of paying salaried employees competitive wages and employee benefits can add up.
• May feel stressed: Salaried employees may feel taken advantage of and experience undue workplace stress when they work excessive hours without additional compensation. This could lead to employee burnout and affect employee development and retention.

Danielle Bauter contributed to this article.