How do you calculate the total cost of an employee?
An employee costs the company more than the gross salary on the payslip, and there is a clear gap between that and the net pay the employee receives. Headcount plans and budgets should be built on a calculation that understands all three numbers.
In hiring and pay discussions, three different numbers come up: the net pay the employee will receive, the gross salary in the contract, and the total employer cost the company actually bears. The gaps between these three are the most common reason personnel costs are budgeted wrongly.
This article follows the Turkish payroll system.
From net pay to gross salary
Net pay is gross salary minus the deductions made on the employee’s behalf. The main deductions are:
- Employee social security contribution: the employee’s share of social security and general health insurance premiums.
- Employee unemployment insurance contribution.
- Income tax: calculated on a progressive scale based on the cumulative tax base.
- Stamp duty.
The portion corresponding to the minimum wage is exempt from income tax and stamp duty. Because rates, ceilings and brackets change with the parameters announced each year, the current values for the period should be used.
The cumulative base effect
Income tax is calculated on the base accumulated since the start of the year. As the base moves into higher brackets, the tax rate rises. An employee whose gross salary stays fixed all year may therefore see net pay fall in later months. Where pay is agreed on a net basis, the gross salary, and so the company’s cost, rises during the year. This effect is a frequent source of budget variances, particularly for positions with a net pay commitment.
From gross salary to total employer cost
The company’s cost does not stop at the gross salary:
| Item | Explanation |
|---|---|
| Gross salary | The salary in the contract |
| Employer social security contribution | The employer’s share of social security and general health insurance premiums |
| Employer unemployment insurance contribution | |
| Incentives and support (−) | Reductions in employer contributions if conditions are met |
| Benefits | Meals, transport, private health insurance, bonuses |
| Severance liability | An obligation that builds up with length of service |
| Unused leave | Leave liability accumulated at year end |
Severance pay is not paid monthly, but it builds up every month. Ignoring it as a provision in the budget and business plan can lead to an unexpected cash outflow later.
Implications for the budget and headcount plan
- The planning unit should be total cost. A headcount plan built on gross salaries will systematically under-budget personnel costs.
- Timing matters. Start dates, pay-rise periods and bonus months should show separately in the cash plan. Because social security contributions and withholding taxes are paid the month after salaries, the cash outflow is spread over two dates.
- Run scenarios. Changes to the minimum wage and payroll parameters can noticeably change personnel costs, even in mid-year.
I built the Payroll Simulator to make these calculations quickly and consistently. I explain where personnel costs sit in the budget on the FP&A page, and where tax and social security payments sit in the cash plan on the tax from a CFO’s perspective page.
Frequently asked questions
Why is grossing up from net pay difficult?
Because income tax depends on the cumulative base and brackets, and the exemptions depend on the minimum wage, the gross salary that delivers a given net pay can differ from month to month. It can only be calculated correctly by modelling the whole year together.
How much do incentives change the total cost?
It depends on the type of incentive, the employee’s profile and whether the company meets the conditions. Incentives should be included in the budget only once the conditions have been confirmed.