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Calculator on red desk to determine cost to terminate an employee

The Hidden Cost to Terminate an Employee

Comparing termination to the cost of re-training

Terminating employees can be a challenging decision. Sometimes the need to terminate is caused because the employee lacks productivity, sometimes it’s because of their behavior. And sometimes budget constraints warrant a termination. At times, it’s a mixture of all three. But we feel that business leaders should be aware of the cost to terminate an employee, especially if they are in an industry where the role NEEDS to be filled quickly. Terminating employees can impact the bottom line.  

Calculating the cost of terminating an employee is an important part of determining how and when to terminate. Often, indirect costs don’t find their way into the equation. Things like severance payments are pretty clear. But other things – like the cost of work which peer employees must assume, or unintended turnover after a termination – are harder to see ahead of time. 

Clear cut costs

When an employee leaves, paying out separation benefits such as a severance or accrued time off is a direct cost. Other direct costs include the cost of hiring a replacement, posting the job, and hiring a recruiter. 

Severance

Severance is considered a mutual agreement between employer and employee. There’s actually no federal or state mandate requiring it. But if you need to terminate through no fault of the employee, it is best practice to offer severance. It’s good to have some internal guidelines on what you typically offer a departing employee. We’ve seen companies offer anywhere from 2 weeks to 6 months.  It’s important that you have consistency here and document how much severance you’re offering and WHY you’re offering that mount.  Employees will compare what’s being offered. So to keep morale high, stick to a number or range and go from there.

Hiring a replacement

There is a lot that goes into replacement costs. You’ll need to post the job somewhere visible in order to attract qualified candidates. A recruiter may need to be contracted. You’ll need to interview candidates. You may even need to pay for travel costs for out-of-town candidates (in a post-Covid world). This adds up.

Indirect costs

Here’s where things become harder to calculate. Nevertheless, we take budget planning practices from Project Management skills to show what many overlook. Specifically, that when someone is terminated, there is a cost to transfer her or his work to a peer employee. 

Additional work performed by other employees

There is still work to do after deciding to terminate someone: the work that the departing employee performed. This work may need to be cut back to the minimum viable amount while you search for a replacement for the role. In Project Management best practices, you assign time and cost per hour to tasks to complete a project. These tasks need to be reassigned to a peer employee until a new hire can be found, trained and (eventually) becomes productive. This peer employee may have her or his own plate full, so productivity could suffer as well. It helps to be able to calculate that lost productivity in the time period post-termination and pre-new hire. It is an extra cost to the company, since the company will see the loss in achieving operational goals. 

A 2016 report from the Society for Human Resource Management (SHRM) shows the average employer requires 42 work days to fill an open position. Then you need to add a similar amount of time for the onboarding period until the new employee is ramped up and fully productive. So the time for this overlap work during the search can extend to 8 pay periods. 

Lost knowledge

Another cost to terminate an employee arises when they take their know-how with them. It could be job-specific procedures, contacts, industry knowledge, and/or information. This is a cost that is hard to quantify, and could be monetized in a number of ways. 

We like this insight of Thomas Watson, IBM’s CEO from 1914-1956.

“Recently, I was asked if I was going to fire an employee who made a mistake that cost the company $600,000. No, I replied, I just spent $600,000 training him. Why would I want somebody to hire his experience?”

Final considerations to limit turnover

As a last thought before the calculator, there are ways to prevent turnover and save through employee retention. Investing in these means can have a long-term payout. It’s not a fool-proof list, but should give you some guidance and “should-be” situations.

  • Have a well-versed onboarding process for new employees to reduce anxiety and shorten the learning curve. It goes a long way. Most employees remember how their first days went – for good or for bad.
  • Put together a handbook and ask everyone to read and acknowledge receipt.
  • Create job descriptions, if not done already, even for current employees. Make sure roles are clear. Communicate expectations clearly to your employees.
  • Pay employees fair wages. Besides being the right thing to do, it will also cause less hassle and cost. Certainly some jobs are more highly valued than others, but you should always strive to pay employees justly.
  • Solve disputes and issues promptly and fairly.
  • Promote a positive company culture and make sure employees are heard and don’t feel intimidated.
  • Allocate a monthly, quarterly or annual budget to train your employees. Make them better incrementally, and they will thank you for it. So will your business’s productivity.
 
This brings us to the cost analysis that we think every business leader should consider before deciding to terminate an employee. 

Termination Cost Calculator

If your thought is that “this person isn’t producing,” then use this calculator first. It can help you see the potential cost to train or further develop the skills of the employee before deciding to terminate. It gives you a view on the cost of tasks transferred to a peer employee so you can better see the total cost of termination or re-training.

Included in this calculation are the above considerations. Terminating an employee cuts into productivity and achievement of operational goals. Compare these costs at the bottom of the calculator.

Suitless is here to provide you with HR and Finance advice. If you need to terminate, regardless of cost, review the tips in this eBook (click here) regarding employee termination to do so compliantly

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