Should You Pay Employees Hourly or Salary?

Determining how you pay employees can play a huge role in how your employees work and your company's overall financial performance, regardless of what industry you're in.

It's a question I frequently get asked by my clients in the residential construction space, especially regarding roles like project management.

Let's break down the differences and pros and cons of each pay structure. 

Hourly, Salary and Contract Employees

Typically, employees fall into one of three categories: hourly, salaried, or on contract. Each type of position represents a different way of engaging with a company and has pros and cons.

Hourly Employees

Simply put, an hourly employee is someone who receives an hourly wage (X dollars per hour) to perform their job. They are paid a base rate for their work that doesn't, by default, include other compensation or benefits such as performance bonuses or health insurance. Their hours are tracked on a time-tracking system and paid out according to the company's established pay periods, less any federal and state or provincial deductions.

Hourly employees don't have a set annual wage in their employment contract. Their employee compensation can fluctuate based on the hours they worked during that time.  

One of the key differentiators (and benefits) to being an hourly employee is that they are eligible to collect overtime pay for extra hours worked over and above a regular work week. Salaried employees do not qualify for overtime and earn the same amount regardless of the number of hours worked.

The rules for overtime pay are federally regulated in Canada and the USA at a rate of not less than 1.5 times the amount of hourly pay, regardless of province or state of employment.

Salaried Employees

A salaried employee is someone who receives a set annual salary for their work, divided into equal weekly or biweekly pay periods. 

Unlike hourly employees, who have more flexibility in how much they can earn at a job per year, a salaried employee's paycheck is the same each time. However, they have more stability because they know exactly how much they will earn each month even if they didn't work as many hours.

Salaried positions often come with other forms of compensation, such as commissions and bonuses, that can be tied to a mix of individual and company performance. It's also commonly thought that one of the bigger perks of being salaried, aside from paycheck consistency, is the inclusion of healthcare and other benefits plans. And while most salaried employees do receive some sort of benefits package, it's typically done at a company's discretion for all its employees, meaning that if a company has health benefits, it's usually offered to both salaried and hourly employees.

Contract Employees

The third type is a contract employee, who is self-employed and hired by a company for a specific project or timeframe. Contract employees are typically paid hourly and submit their hours similarly to hourly employees, but they have one big distinction in that they are not company employees. 

This means contract employees are responsible for reporting and paying their own taxes and worker's compensation, unlike hourly employees - who are part of a company's payroll and have all government deductions submitted on their behalf.

Contract employees are usually hired for short-term projects that require niche expertise or when extra labor is needed on an as-needed basis.

Subcontractors are a good example of contract employees, but they are not often hired hourly but for a specific job. They are given the outcomes and parameters for their work, but they (or their team) don't report to company employees and aren't part of the company's payroll. 

A cautionary tale for working with subcontractors and hourly employees: treating hourly employees as subcontractors and paying them as contract employees can be tempting, thereby reducing the payroll and source deduction burden on the company. However, the Canada Revenue Agency and U.S. Internal Revenue Service classify this as illegal because hourly employees managed by a company, scheduled at different job sites, and measured against company performance standards must be paid on company payroll and have payroll deductions submitted promptly.

Understanding Paid Time Off (PTO) for Hourly vs. Salaried Employees

In the working world, there are several different types of "Paid Time Off," such as statutory holidays, vacation days, vacation pay, sick days, and personal days, and they can be generally defined like this:

Statutory Holidays are public holidays generally established by law and are usually non-working days during the year.

Vacation Days are a designated period of time employees can take off from work, usually with pay, to relax and rejuvenate. This definition differs between the U.S. and Canada (see below).

Vacation Pay is an amount accrued for each hour a Canadian employee works and is added to their wages each pay period.

Paid Sick Days are days when an employee receives pay while absent from work because of illness.

Paid Personal Days are time off employees take for reasons other than vacation or personal illness.

Statutory holidays and vacation days can be legally mandated and apply to hourly and salaried employees. Employers may also offer paid sick and/or personal days as an added incentive.

Canadian employees, whether working hourly jobs or on salary, are entitled to vacation and statutory holiday pay. The amount and calculation can differ based on the province of employment. Both types of employees pay into are entitled to receive employment insurance benefits and the Canada Pension Plan (CPP). 

The government of Canada does not federally mandate paid sick leave but some provinces do have paid sick leave regulations.

In the United States, the Fair Labor Standards Act does not require payment for time not worked, such as vacations or holidays (federal or otherwise), but a company may choose to offer them to their employees. Both hourly and salaried employees can participate in any optional 401(k) programs their employer provides. Both types of employees also pay a U.S. federal payroll tax, or FICA (Federal Insurance Contributions Act), an employee's contribution to fund Social Security and Medicare.

Federally, additional paid forms of PTO, such as paid sick or personal days, are not mandated. However, the Family and Medical Leave Act (FMLA) requires covered employers to grant qualified unpaid leave, which includes sick time. Many U.S. states have their specific laws regarding paid sick leave.

Pros and Cons of Hourly vs. Salaried Employment

Salaried and hourly positions have benefits and drawbacks from both employee and employer viewpoints. Let's explore some of them.

Hourly

Employees who are paid hourly benefit from the ability to earn additional pay from overtime when they exceed a regular workweek, statutory holiday and vacation pay, and, if offered, participation in company benefits programs. However, they are susceptible to loss of pay when work is slow. 

Since their hours can be adjusted or eliminated to match business volume, their weekly or biweekly paychecks are less consistent. Unlike salaried employees, hourly-paid employees can be easily laid off when there isn't enough work. Depending on the labor laws in the state or province in which they are employed, hourly-paid employees can be eligible for severance pay if laid off or terminated, but it is very uncommon.

Employers of hourly employees benefit from aligning payroll costs with high or low-revenue seasons. They can tie compensation to billable time, particularly in cost-plus billing models where hourly employees must submit timesheets for hours worked.

However, manually calculating hourly pay means more time spent on payroll and possibly more mistakes, which takes up time that could be spent on other revenue-generating tasks. 

Click here to learn how to avoid this by using a simplified digital system to capture time by project and by cost code to help stave off those mistakes.

Paying employees hourly wages can also increase the company's costs for overtime pay because overtime hours can burn through a budget quickly, leaving business owners with a choice of eating those costs or having tough budget conversations with clients. And more often than not, residential construction business owners will choose to just "eat those costs" rather than ask a client for more money.

Speaking of clients and money, hourly wage employees can create cashflow challenges because fluctuating payroll costs are at the mercy of potentially slow-paying clients. Learn how to manage cash flow to avoid cash crunches here.

Salary

Employees in salaried positions enjoy the benefit of stable regular paychecks regardless of the company's volume of business. However, they do not qualify for overtime pay for additional hours worked above a regular work week of 40 hours, meaning they could be asked to complete work after hours or on weekends with no additional financial incentive.

They usually also include health benefits and other incentive programs, like paid time off. Subject to state and provincial regulations, they are eligible for severance pay if terminated. 

Employers of salaried employees maintain consistent payroll costs regardless of business volume, which is beneficial during busy seasons but less so during slow periods. Consistent payroll costs also mean less time is spent on payroll processing, and no overtime costs are incurred for the company.

However, cost-plus employers may struggle with unbillable time because salaries are based on 40-hour workweeks. I've seen situations where salaried roles, like project managers, for example, submit timesheets for 34-36 hours per week for billing. Multiply that by each salaried employee, and that accumulates to a lot of unbillable hours.

How to Decide Which Method is Best For Your Business

In a perfect world, whether employees are paid an hourly rate or receive salary pay shouldn't affect their performance or the results you expect from them. Employees should complete all assigned tasks efficiently and effectively regardless of their pay structure.

However, several factors come into play when determining which payroll method is best for you.

What Worked for Me

In my 21+ years as a builder in cost-plus and fixed-cost companies, I found that hourly compensation was the best option for almost all positions. 

Here's why:

Teams were more motivated

One of the main reasons for this is that our team members were incentivized to work more hours, as it directly correlated to earning a full paycheque each week or bi-weekly period. When more hours were worked, we were more productive as a company. 

It's more profitable for cost-plus builders 

Salaried employees often neglect tracking their hours and filling out timesheets accurately, leading to unbillable hours and lost billable revenue. In contrast, hourly workers are incentivized to log time accurately, maximizing billable work.

It expanded your throughput capacity

If your team works more hours, you'll finish projects faster, making your clients happier. The added throughput will drive up the bottom line in your financials, leaving you available to handle more project volume each year.

The Bottom Line on Hourly vs. Salary Employees

How you compensate your employees can significantly impact your company's throughput, gross revenue, and profitability. 

Understanding the distinctions between hourly and salaried employees is essential to making that decision.

In my experience as a builder, hourly compensation proved more beneficial for billing volume, team motivation, and project productivity.

However you decide to pay your employees, be it hourly or on salary, tracking their time is crucial to learning how effectively you estimate work. The best way to do that is to use digital software to track hourly inputs across projects and cost codes.

I created BUILDWISE to help builders organize their project finances, monitor their margins in real-time, and make sound financial decisions.

Click here to start your free trial today.