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Question

I am going to be hiring an employee for my small family business and needed some advice on how to determine how much I can afford to pay.  Please let me know what you think.

Answer

Here are a couple of thoughts in terms of what level of pay to pay an employee:

• The Candidate - Candidates usually have a notion of what they need in terms of compensation based on their last job and pay level and based upon their need (and rarely on their ability to add value.)  I always try to start off the compensation conversation by asking them about their compensation requirements.
• The Market - Try to determine the market rate of compensation for the position you have open.  This market rate could be as simple as what you were paying the last employee in the same position.  For a new position, this will be more difficult in a small company context.   Websites such as www.Salary.com can be helpful in gauging compensation, and so can hiring sites as you browse candidate's resumes and see the jobs they are searching for and their requested compensation.  The more candidates you interview for a particular position, the more you can zero in on a "market" rate for the position.
• The Job - Try to determine the value the candidate can create for the particular job the candidate will be doing.  While this is very easy for contract services firms such as an IT services firm that is looking to fill a position for a software programmer that they intend to hire out for $75 per hour and they are looking to make a gross margin of 50% on the candidate after all expenses are paid, it is a lot more difficult for an non-billable staff position or in a product company.  Nevertheless, if you can figure out what it is worth to the company you now have a high water mark that you do not want to go over, since you will want to create margin on top of what the employee is paid.  I would always encourage an employer to figure out a bonus plan that pays the employee for performance so there is a direct link between their performance and their pay.  The more you can pay "by the piece", the better in terms of aligning the employee's interests with yours.
  
• The Company - Analyze your past financial reports to determine overall how much additional compensation the company can afford and the impact of hiring the new candidate.  If this is a replacement for a past position, then simply analyze any increase in salary over the last employee to determine if the company can afford to hire the candidate.  If this is a new position, then calculate the total cost of hiring for the new position.  Be sure to include all the appropriate taxes, insurance, benefits and office equipment costs.  Ongoing taxes, insurance and benefits costs can run as much as 25% - 50% of the base pay.  One-time office costs may include the additional capital expenditure of office equipment such as furniture, lighting, computer, software, telephone, etc.  There are also significant soft costs with every new hire such as their time spent in training prior to being fully productive and the lost time you spend training them.  Be sure to give yourself plenty of margin in terms of cash flow so you can avoid any negative surprises.  You should also assume a dip in productivity in the two or three months following a new hire in a small company due to all the distractions and settling in time and effort.
  

There are also several other relevant posts to read on employees here.