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Analyzing Overtime Costs: A Strategic Step for HR

Analyzing overtime costs can be an important strategic step in determining when to hire new workers and improve efficiency in operations, labor costs and productivity.

Overtime vs. More Hires

An important strategy for making hiring decisions is looking closely at the costs of overtime compared with the costs of hiring additional employees. Those costs will vary based on the employee's salary and other factors.

Here are three steps to help determine whether it's best to pay overtime to current employees or hire new workers.

1. Determine Fixed Costs of Hiring an Employee

Those costs may include an annual cost for health insurance, benefits, paid time off and other paid leave mandated by law or through an employer's policy. Multiply the potential employee's daily pay rate by the total number of paid days off they are entitled to each year. Fixed costs will stay the same — regardless of the number of hours a person works.

2. Determine the Costs of Paying Overtime

If an employee's hourly wage is $15, your business pays them approximately $600 for a 40-hour workweek. If the employee's regular rate of pay is $15 per hour, under the FLSA they would be entitled to time and a half for all hours worked over 40 hours in a workweek, which amounts to $22.50 per hour. If that employee works an extra 10 hours, they cost you $825 in weekly payroll. These are variable costs and do not take into consideration any state overtime requirements, which may be even more generous to employees.

3. Crunch the Numbers

If you only need 10 extra hours of work out of a $15-per-hour employee, it may not be worth the cost of hiring a new employee and paying the fixed employment costs for a new person. But at some point, it will become cheaper to hire a new employee — even part time — than to continue paying for overtime hours. Analyze the fixed costs and variable costs of hiring new employees and paying for current overtime to determine your organization's break-even point.

Using Overtime Strategically

Many employers use overtime to cover for absences or allow employees to catch up on missed work. But rather than using overtime as a last-minute approach to playing catch up, businesses can benefit by being more strategic and by analyzing overtime costs. To use overtime strategically, determine how you might use it over the long term to meet production demands at certain times of the year or to fulfill uncharacteristically large orders.

With an integrated, cloud-based HR system, leaders can quickly access a wealth of data and leverage it to keep costs down. Here are a few strategic steps you can take to better maximize your use of overtime:

  • Figure out your current usage. Dig into your internal data to study which employees or departments incur overtime most often and for what reasons. Most modern systems allow you to quickly create reports showing which employees work the most overtime, which departments work the most overtime and how much those overtime hours cost the business. By mining that data — and conducting conversations with managers in key departments — HR leaders can develop valuable intelligence and make strategic decisions. 

  • Establish policies. Once you understand how your business currently uses overtime (and how much it costs), you can use that knowledge to establish long-term policies for overtime usage. For instance, if certain departments seem to overuse overtime, you may institute guidelines that allow them to use overtime only during certain busy months, or put a cap on the number of overtime hours employees can work during a month or quarter. Through analyzing current overtime usage, figure out for which positions overtime is necessary and only allow it for those positions. That way, you use overtime strategically and cut costs by avoiding its overuse. However, it's important to be consistent if you only allow overtime for some positions and not others. You should also have policies that require employees to obtain written authorization before working overtime, so you can more proactively manage it. Even so, employees who exceed the cap or work overtime without authorization must still be paid for all hours worked. 

  • Cross-train employees. Consider cross-training employees to avoid overuse of overtime when employees are absent. That way, employees who normally work in other areas can help with certain projects when key personnel are away. 

  • Strike a balance. While many employees appreciate the extra income offered by working overtime, they also need time for rest and the freedom to schedule activities outside of work. Even if some overtime hours are mandatory or built into the work schedule, ensure that most overtime hours are optional so that employees won't feel bound to work and morale doesn't suffer. Also, proactively manage employees who incur excessive absences. 
Overtime is not just a quick fix to meet last-minute needs. If used strategically, it can also help you manage costs and improve production.

This story originally published on SPARK, a blog designed for you and your people by ADP®. Learn more about how ADP’s small business expertise and easy-to-use tools can simplify payroll & HR at adp.com.

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