Expert: Ed McFarland - 11/2/2007

Question
My company is a 10 year old company of a couple hundred employees.  They have grown quickly without regard to turning a profit in the early years but since going public there is pressure to turn a profit.  This year we have gone through some severe cost cutting measures in an attempt to turn a profit, including a staff reduction.

The trend that is occurring is no permanent employees are replaced with new hires but there seems to be an ability to bring on contract employees at the drop of a hat.  This is in all departments, engineering, I.T., accouting, even contract employees in leadership positions.  

This seems quite odd to me since the cost of these employees is greater than a permanent employee and there is no chance for continuity as the contract employees will leave eventually, be it 3 months or 12 months.  In a business which has a very long learning curve with highly technical products, I simply cannot understand the logic of bringing on contractors instead of hiring permanent.

My question:  Is there some great accounting advantage to hiring a contract employee?  In the manufacturing dept., I have heard they can bring on permanent employees who's cost is embedded in the cost of the product (i.e. technician level), but not the type of employees who's cost is accounted for as overhead (manufacturing engineering level).  That led me to believe there may be an accounting reason for the whole strategy of hiring all consultants / contractors and very few permament employees.

Does this pattern of hiring inidicate a likely outcome, such as preparing for the sale of the company?

Thanks for your response.

Answer
It's a short term fix to respond to the pressure of being public.

A contract or 1099 employee has no additional costs beyond what you pay them. Regular or W2 employees carry extra payroll costs such as benefits, Social Security and unemployment insurance. It can be about another 30-40% above the gross paycheck amount.

It seems that the company has swung from one extreme to another. Based on what you've said, the company is still in a growth cycle but now with the additional attention of being public, greater care needs to be taken with assuming costs.

Watch top management, keeep an eye on whether they are buying or dumping shares, staying or leaving and so forth.

Good luck