Friday, August 05, 2011

SOP Friday: Hourly vs. Salaried Employees

When you have employees, one of the most important questions you need to address is how you pay them. The two most common options are to pay hourly and to pay a flat fee per month (salary).

This is also a very highly regulated element of business, so the simple division between hourly and salary isn't that simple any more. Many states have adjusted the "rules" about these two types of employment, applying a variety of requirements and options that might surprise you.

Here are some thoughts on developing a policy that works for you.

- Overview -

Salary employment means that you agree to pay based on an annual sum, divided evenly by the number of pay periods in the year. For example, a salary of $60,000 and a monthly payroll would result in twelve payments of $5,000 each. Minus taxes, deductions, etc.

Normally, salaries are reserved for supervisors, executives, and managers. Others may be eligible in your state. There are both Federal and State laws about this. In most cases, salaried employees keep track of their time, but only so the employer can calculate things like the cost of delivering services. An employee's salary is stable whether they work 30 hours or 60. (There are some exceptions to this in some states.)

The primary benefit that most employers see is that they can work their employees harder without paying more money. So lunch times disappear and employees are encouraged to stay late, come in on weekends, and not receive extra money. The employer has a stable cost and can (theoretically) increase profit by getting additional "free" labor out of the employee.

In reality, salaried employees tend to receive higher benefits, take off more time during the work day for (paid) trips to the bank and for medical appointments. In other words, the employees make up for a lot of that extra work by taking time where they can find it.

And, to be honest, a good employer won't take advantage of employees.

Hourly employees are just that: Paid per hours worked. The norm is that you have to pay extra for overtime, normally 1.5 times the standard rate. You can pay more. I think the 1.5x number is required by law, but I don't know for sure. In California, overtime is calculated every day as well as every week. So anything over 8 hours is overtime, even if the employee is not over 40 hours for the week.

Many hourly employees are not paid benefits. But we offer the same benefits to anyone who regularly works 30 or more hours per week. Benefits can be very expensive or very manageable, so you need to consider them carefully (we'll cover benefits in a future topic).

The great advantage for employers offering hourly labor is that you can increase and decrease the hours as needed to stay profitable. This is sometimes tough on employees, but not always. We have been amazed, especially with young employees, that they don't want 40 hours a week. Some of them are constantly taking a day here and a day there just to go fishing. Many like leaving at 4:00 PM.

We had one employee for three years who almost NEVER worked more than 37 hours a week, no matter how much work there was to do. And it's not because we pay too much.

[Side note: Money is NOT much of a motivator for employees. I know that sounds odd as a manager/owner. But most employees are looking for other ways to be satisfied in their jobs. There are seven million articles on this. Here's one: Is Money an Effective Motivator at Work? by Taras Bereza.]

You can also have additional pay levels. For example, you can pay 2x for work after 12 hours in a day or for work on holidays. Just don't make it too complicated.

Super Important Advice:

If you CAN pay hourly, you have a huge tool for managing your expenses when workflow diminishes.

Employee expenses are the single greatest expense you have. When you have a cash flow crunch, cutting employee expenses is sometimes the only meaningful way to reduce your overhead.

It is hard to lay people off or reduce hours. But your business' survival may depend on it. Paying employees by the hour allows you to reduce hours and see a pretty quick cash flow change. With salaried employees, they're either ON or OFF the payroll, which can be tough.

If you can, I recommend that you pay your employees by the hour.


There are many ways to set bonuses and many kinds of bonuses to offer. We could have a whole separate article on this. But the most important thing to remember is:

Only pay bonuses from net profits . . . and only if you're exceeding your established goals.

Ooooops. You don't have established goals for profitability? Well, take care of that!


One big difference between salaried and hourly employees is how holidays are handled. If someone is on salary, they are not generally required to work holidays. Your company needs to post an official list of your company holidays. Post it for employees - and tell your clients.

If you don't do this, you'll have people saying "It's Groundhog Day. Everyone knows that."

There are Federal Holidays and State Holidays. You might add the employee's birthday as a holiday. You might add the day after Thanksgiving (as we do), or choose not to celebrate Columbus Day (we don't).

Like everything else: It doesn't really matter what you do here, as long as you have an agreed upon policy and you post it.

Hourly employees are another story. Generally speaking, if they're not scheduled to work on holidays, then they don't get paid for holidays. If they are scheduled, however, then you might want to pay more for working the holidays. You are not required to do this, so you need to decide what your policy is.

- Implementation Notes -

Posters and Advice

As you can see, this topic can be quite overwhelming.

Each state, plus the Federal government, have posters with many of the most important rules and regulations. You need to post these somewhere. In California they take up approximately one entire wall of the break room.

Believe it or not, those posters can be a great guide to what you can do, what you have to do, and what you can't do. There are a few that actually have blank spots for you to fill in variables like rate of pay for overtime.

Good advice can also be found with your payroll service. We have used ADP, Paychex, small Mom-and-Pop payroll services, and those offered through the bank. In all cases there was someone who knows a LOT about employment rules and regs. You're paying for this with your monthly fees, so you might as well use it.

Another good source of advice is your accountant or enrolled agent. They may offer a payroll service. But if nothing else, they will know someone. Get a referral to a specialist.

I'm not a big fan of downloading someone else's sample employee handbook from the Internet unless you intend to pay your attorney to vet it for your state/province. But there are good, reasonably-price, up-to-date sample handbooks for sale for every state/province. As I mentioned before, this is a very highly regulated area, so don't put yourself in a position to do things illegally because you got the wrong sample.

We have an employee handbook based 95% on a product sold by the California Chamber of Commerce. All changes have been approved by our attorney. We have a lawyer that we use to advise us on all employment matters. We don't give him a lot of work, but enough that he knows who we are when we call.

Final Notes

If you do what makes sense and seems like the right thing to do, you'll probably be just fine. If you use a big payroll service like ADP or Paychex, their processes will help keep you within the law.

But take this stuff very seriously and develop processes and written procedures so you don't have to just make stuff up when an issue comes up.

And please consider paying hourly if you can. It might save your business with cashflow gets tight.

Your Comments Welcome.

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About this Series

SOP Friday - or Standard Operating System Friday - is a series dedicated to helping small computer consulting firms develop the right processes and procedures to create a successful and profitable consulting business.

Computer consultants tend to be very good with computers, of course. But that doesn't make them good with the business side of the business. This series is intended to give you a big step up in creating the business you want to be. After all, the best way to become the business you want to be is to start behaving that way now.

This is also a debate at times. So feel free to post your comments and recommendations. If you have alternative "standard" operating procedures, please share them as well.

This series started May 13th. You can find the whole series by simply entering SOP Friday in the search box above (the one for this blog, not necessarily Google search).

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Next week's topic: Ticket Statuses to Use and When to Use Them


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