Each week, our TechRepublic financial team fields a question from working IT pros about the mysteries of balancing those budget sheets. This week’s question examines the advantages of hiring a contractor versus hiring a full-time employee.
An IT pro asks: I've been asked to determine whether a full-time hire or a contractor is the best answer for a new development need. What are the financial upsides or consequences (taxes, etc.) of using contractors? Their rates seem outrageous, so I'm guessing there must be some benefit I'm not seeing.
The Accountants: There are several potential benefits to using outside resources or contractors rather than adding staff to your organization. Assuming that either a contractor or regular employee can do the work effectively, you should weigh these advantages very carefully before making a decision.
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Here is a simple example. Let’s say for a long-term project you have the option of hiring a full-time employee at $80,000 per year or paying a contractor $50 per hour. Using 2,080 working hours in a year (40X52), the contractor would cost the company $104,000. Many managers would immediately rule out the contractor due to cost. However, there are several more issues to consider.
First, do not overlook the cost of benefits that must be paid to regular employees but not to contractors. Expenses such as training, medical/dental/life insurance, paid vacation, sick time, profit sharing, 401K matching, worker’s compensation, and several others depending on your company, all must be factored in to the analysis. One of the best reasons for utilizing contract help is that your company is not responsible for these benefits. Payroll and social security taxes also represent an expense for the company only in the case of adding staff, not outside contractors.
But how do you calculate these costs?
Most organizations have an idea of the “fully-loaded” cost associated with hiring a new employee. Ask your finance or budgeting department for guidance.
Fringe benefit costs could run as much as 20 to 50 percent of salary. For example, using a benefits cost of 30 percent of salary, that new hire now represents a cost of $104,000 per year (80,000X1.30), the same as the contractor.
Second, outside contractors provide a great deal of flexibility to the organization and can be used at the convenience of the company. This is especially helpful in situations where the project is altered in some way. If, for example, the company changes direction and the project gets killed, or assigned a lower priority, there is no employee to fire (or unemployment paperwork to process.)
If the project is revived, one phone call brings in a new contractor. There is no lengthy (and costly) recruiting process. This flexibility can save the company a lot of money in personnel costs in the long run.
Also, let’s say the person brought in to do the job simply isn’t performing to the expected level. If you’re dealing with a contractor, it is an easy fix: You tell the contractor to be on their way, and you call someone new.
On the other hand, if you went through the process of adding staff to your organization, you have to follow the rules prescribed by human resources with regard to coaching, disciplining, documenting, and terminating employees. Sometimes it can actually be very difficult to fire someone. It is rarely as easy as sending a contractor home for good.
When deciding between outside help and internal staff increases, always keep in mind the hidden costs associated with the hiring of employees. These costs may be difficult to calculate precisely, but an estimate can give you the information needed to make a decision.
Once the cost factor is determined, remember the intangibles like flexibility to the organization. This flexibility could be worth more than a small gap in cost; look beyond salary and hourly rates.
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