What your staff really cost — and why most SME owners underestimate it

The gap between salary and true employment cost

When a business owner offers someone £35,000 a year, the number that goes on the job offer is £35,000. The number that comes off the business bank account each month is closer to £42,500. The difference — roughly £7,500 per year, or £625 per month — is the on-cost burden that sits invisibly on top of every salary in the business.

That on-cost breaks down into three components. First, employer National Insurance. From April 2025, the rate increased from 13.8% to 15% and the secondary threshold — the salary level above which NI applies — fell from £9,100 to £5,000. For a £35,000 salary, employer NI is now approximately £4,500 per year, up from £3,582 before April 2025. That is nearly £1,000 more per employee per year, arriving with limited notice and no offset.

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Second, employer pension contributions. Under auto-enrolment, employers must contribute a minimum of 3% of qualifying earnings. For a £35,000 salary, that is approximately £840 per year. For businesses that contribute more than the statutory minimum, the figure is higher.

Third, other on-costs — training costs, recruitment fees amortised over tenure, equipment, software licences, and any benefits provided. For most SMEs, this adds a further 2–4% on top of salary. Add these together and the true fully-loaded cost of a £35,000 employee is approximately £41,500–£43,000 per year.

The most common consequence of underestimating employment cost: pricing that is systematically too low for service businesses, and overhead budgets that are consistently understated for all businesses. Both problems are invisible until they appear in the P&L.

What changed in April 2025 — and why it matters now

The April 2025 National Insurance changes were the largest single increase in employer NI costs in recent memory. The rate increase from 13.8% to 15% sounds modest. The threshold reduction from £9,100 to £5,000 is the more significant change. It means employer NI now applies to a much larger portion of each salary, and at a higher rate.

For a business with 10 employees at an average salary of £32,000, the combined impact of these two changes increases the annual NI bill by approximately £10,000–£12,000. That is a cost that simply did not exist in the previous financial year. If it has not been reflected in pricing, it is being absorbed by profit margin.

Many SME owners have not updated their cost calculations since the change. Their pricing still reflects the old NI rate. Their budgets still use the old NI threshold. Every quote produced using these numbers is potentially underpriced by a meaningful amount.

Revenue required to justify a hire

The most commercially useful way to think about an employment decision is not "can we afford the salary" but "how much revenue does this role need to generate to be commercially neutral." This reframes the hiring decision from a cost decision to a revenue decision.

The calculation is straightforward. Take the fully-loaded annual cost of the role. Divide it by your target gross margin percentage. The result is the minimum annual revenue the role must generate — or enable — before it contributes a single pound of net profit.

For a £35,000 salary with a fully-loaded cost of £42,000, at a 40% gross margin, the revenue required is £105,000 per year — £8,750 per month. That is the revenue the business must generate attributable to that role before the hire pays for itself. If the answer is unclear before you make the offer, the decision is being made on instinct rather than data.

How this affects pricing for service businesses

Service businesses — consultants, agencies, contractors, professional services firms — have labour cost as their primary direct cost. The margin they generate is almost entirely determined by the gap between what they charge and what the people doing the work cost.

If your cost calculations use salary rather than fully-loaded cost, every piece of work is systematically underpriced. The gap is 20–25% of actual labour cost. On a project priced at £10,000 where labour accounts for £6,000 of the cost, using salary rather than fully-loaded cost means you have missed approximately £1,200–£1,500 of real cost. Across a year of projects, this creates a consistent profit drag that looks like weak trading but is actually weak pricing.

The National Living Wage cycle

For businesses with employees at or near National Living Wage levels — hospitality, retail, care, cleaning, logistics — the April increase creates a predictable annual cost increase that must be modelled in advance. The NLW rose 6.7% in April 2025. For a business with 15 NLW employees working 40 hours a week, that increase added approximately £18,000 to the annual wage bill before employer NI effects.

Businesses that model this increase in January and adjust prices in February are managing their margin deliberately. Businesses that absorb the April increase and revisit pricing six months later have already given away three to four months of compressed margin.

What to do

Three practical steps. First, recalculate the fully-loaded cost of every role in the business using the April 2025 NI rate and threshold. If your HR software or payroll provider has not updated these, use 15% on earnings above £5,000 per year. Second, check whether your pricing — particularly if you are a service business — reflects fully-loaded labour cost or salary cost. If it uses salary, every piece of work is underpriced. Third, model the revenue required to justify each role. For every person on the payroll, there should be a clear commercial rationale connecting their cost to revenue generation or enablement.

The LumixAI Headcount Cost Modeller does this automatically. Enter role, salary, NI rate, and pension, and it calculates fully-loaded cost, on-cost premium, and the revenue required to justify the hire at your target gross margin. It applies the current April 2025 NI rate and threshold automatically.