Headcount planning explained: How to tackle budgeting & forecasting headcount (The right way)

Budgeting & forecasting headcount, including how to manage this in a fast-paced environment

Table of Contents

Senior leadership at every company needs to have confidence in the hiring plan. The hiring plan is vital to achieving a company’s business objectives and goals. This is especially true for fast-growing companies because headcount planning is critical to company growth. Over the last couple of years, the labor market has been very tight, so a renewed emphasis has been placed on companies’ headcount strategy. A well thought-out headcount plan is critical in today’s environment if companies hope to achieve revenue growth goals and future workforce needs.

However, the headcount planning process remains one of the most challenging parts of a company’s budgeting and forecasting process. This strategic exercise often leaves business leaders and hiring managers disappointed in the planning process. I cannot count how many times I have seen a budget or forecast be incorrect due to issues with headcount planning.

Common challenges with headcount planning

Some of the challenges companies face with headcount planning include:

  • Current workforce headcount forecasted in the wrong departments/cost centers
  • Incorrect hire dates for new employees
  • Headcount missing from the forecast
  • Failure to forecast overtime or using the wrong rates to forecast overtime
  • Poor capacity planning models leading to not having the right number of people required to perform the work
  • Using the wrong salary assumptions for new employees
  • Using incorrect rates (Mert, Taxes, Benefits ) in the forecast

The above are just some of the many issues companies and business leaders face when building headcount plans. Leaked Amazon documents that appeared in the news recently highlight the challenges HR teams and finance teams experience with headcount planning and the impact a headcount mistake can have on the overall business. Amazon managed to post 24,988 positions in 2022, but according to internal documents, Amazon had only approved 7,798 positions.

This highlights the lack of oversight Amazon had in the planning and hiring process and how difficult it can be to manage hiring targets in a fast-growing company. In the remainder of the article, we will cover:

  • What is headcount planning, and how it differs from workforce planning.
  • What to include in your compensation costs.
  • The common methods used for headcount planning include: Run rate, Name-based, Role-based, Capacity-based, and Project-based.
  • Common things to watch out for in the planning process.

What is headcount planning?

When it comes to headcount planning, let’s define what that includes and how it differs from workforce planning. Let’s have a look at this table comparing and contrasting the differences between workforce and headcount planning:

ASPECTHEADCOUNT PLANNINGWORKFORCE PLANNING
DefinitionHeadcount planning focuses on determining the number of employees required to meet business objectives. This includes forecasting both current employees and new hires.Workforce planning is a broader approach that considers the right mix of skills, competencies, and experience. Strategic workforce planning includes identifying skill gaps and developing plans to manage future professional development.
ScopeNarrower in scope, focusing primarily on the number of employees needed.Broader in scope, encompassing not only headcount but also ensuring employees have the relevant skills, competencies, and necessary career development to be successful.
Time horizonUsually covers a shorter time horizon, often one fiscal year or less.Typically spans a longer time horizon, encompassing both short- and long-term organizational needs.
FocusEmphasizes fulfilling the immediate needs of an organization in terms of employee numbers.Focuses on the strategic alignment of workforce capabilities with organizational goals and objectives.
Primary participantsHuman Resources, Finance Departments (FP&A), Department Managers, and Senior LeadersHuman Resources, Department Leaders & Managers, and Senior Leaders

So what’s the difference?

Workforce planning is much broader than headcount planning and includes a holistic strategy to ensure you have the right number of people with the right skills, competencies, and experience on the team to get the work done. On the other hand, headcount planning is primarily focused on ensuring you have the right number of people and all associated costs captured for budgeting and forecasting purposes. When it comes to headcount planning, understanding all the costs that are typically included in the planning process is essential. Without a complete understanding of what needs to be included, one will often miss something, thus causing the entire plan to be wrong.

Compensations costs

Many companies spend up to 70% of all expenses on labor costs. This includes the employee’s salary and all the additional costs related to the employee, such as bonuses, payroll taxes, recruiting costs, etc. Below is a list of the common costs to include in your headcount planning. The below includes a definition of the different types of costs but does not include the methods used to forecast these costs, as we will discuss methods in the next section.

Salaries

This is the base amount you pay an employee annually. Depending on the employee type, this could be an annual salary amount or an amount per hour.

Merit/Cost of living increases

This is the amount you anticipate increasing employees’ annual salary every year for merit/cost of living.

Bonuses

Most companies have an annual bonus payout where people can earn up to a percentage of their annual salary. The potential bonus earning amount will vary for different job titles and departments. Typically bonuses are forecasted at 100% to start the year and adjusted as necessary by company decision makers.

Incentives

Incentive payments often involve paying individuals and teams for achieving certain targets and goals throughout the year. Incentives are typically paid to non-sales employees such as customer success teams. They are often paid to employees who are not bonus eligible as a way to attract top talent.

Commissions

Sales commissions are paid to sales reps and sales teams and are based on sales targets and quotas. The forecast for commissions will need to cover the company’s revenue targets in the company budget.

Overtime wages

Overtime wages include wages paid to hourly employees who work more than the average hours in a given week. Overtime wages are often used temporarily to achieve short-term staffing needs without hiring additional employees. When it comes to understanding overtime hours, using historical data from your time-tracking system can be incredibly valuable. This information can provide additional insights that you cannot obtain from the general ledger that just buckets the total cost of overtime into one line.

Benefits

Benefits include things like healthcare, tuition reimbursement, etc. Benefits will usually be forecasted as a flat fee per employee but, in some cases, might be a percentage of salary.

Payroll taxes

Payroll taxes vary by geographic region but often include unemployment, retirement, and medical costs. These costs are usually a percentage of total compensation (Salary, bonus, commissions, incentives) and, in some cases, might only apply up to a certain dollar amount.

Training/tuition reimbursement

This includes training costs and tuition reimbursement for eligible employees. This is often a very small amount of overall labor costs and can generally be forecasted based on prior year data with adjustments for any known expenses in the new year.

Recruiting/hiring costs

These costs include external recruiting agency costs, relocation costs, and other one-time costs associated with hiring new employees. One should work closely with your HR professionals to understand these costs.

Severance

Severance is any costs paid to an employee upon involuntary termination of employment. If the company budget includes any restructuring activity that will reduce the workforce, it is important to ensure all severance costs are forecasted.

Attrition

Every company has attrition throughout the year as there will be a market demand for your employees.

Common planning methods

The common methods used for headcount planning include run rate, name-based, role-based, capacity-based, and project-based. Below is a brief explanation of each method and each approach’s pros and cons. Many businesses will use multiple approaches to forecast headcount as different methods will work best for different departments.

Run rate

One of the most simple methods for headcount planning is the run rate method. One way to do this is to take the average cost per employee from the prior year and add it to your anticipated number of employees for the new year. The below table shows a simple example where the per-employee costs each quarter were adjusted by a predetermined growth rate and multiplied by headcount to develop the compensation cost per quarter for the next year.

Pros: The primary benefit of using this method is that it is easy to manage and will be directionally correct.

Cons: The cons include historical averages often having noise in the numbers due to accruals and one-time expenses, and using them often results in inaccurate forecasts. Furthermore, this planning method does not include any reconciliation between employees and departments, which is often a necessary part of the headcount plan to ensure accuracy.

In practice, this method is rarely used as the cons outweigh the pros, and other methods exist that are more accurate and make it easier to provide senior executives with the details they need to manage the business and the hiring plan.

Name-based

Name-based planning is a widespread approach to headcount planning, especially when the business is small enough that you can reasonably include every name in the plan. This process includes listing every single employee by name and using the actual compensation data for each employee. This method tends to be highly accurate because it uses actual cost assumptions. I would recommend this approach for a small but fast-growing company without a capacity-based business.

NAMECOST CENTERSALARYBONUSSALES COM.TOTAL COMPBENEFITSTAXESFULLY BURDENED
Joe MontanaExecutive$300,00035%$0$405,000$15,00012%$468,600
Steve YoungSales$200,0000%$100,000$300,000$15,00012%$351,000
Tom BradyCustomer Support$85,00010%$0$93,500$15,00012%$119,720
Peyton ManningProduct$150,00020%$0$180,000$15,00012%$216,600
Johnny UnitasR&D$160,00020%$0$192,000$15,00012%$230,040

The above table shows what a named based annual planning table might look like for employees. Once you filter it down to the monthly level, you would also include the start and end dates and calculate all the monthly costs and add other assumptions such as training, severance, recruitment, and attrition to the data.

Pros: The biggest benefit of name-based planning is that it is highly accurate and helps you understand how many employees you have and the assumptions used for every single employee, both current and new. This approach allows finance to sit down with the business leaders and share the assumptions used for every single employee.

Cons: Difficult to maintain, especially as the number of employees grows. For example, if you are forecasting a headcount of 5,000 people at a name level, it is probably not realistic. Another big concern is that you have data with every employee’s actual salary, which can create privacy concerns and data security risks.

Role-based

The role-based planning approach focuses on developing an average salary for each role in the company and then forecasting how many employees are required for each role to meet the needs of the business.

ROLEDEPT.QTYAVG. SALARYBONUSSALES COM.TOTAL COMPBENEFITSTAXESFULLY BURDENEDTOTAL COST FOR ROLE
Sales repSales10$100,0000%$100,000$200,000$15,00012%$239,000$2.390M
Account executiveSales5$50,0000%$50,000$100,000$15,00012%$127,000$0.635M
Customer support repC/S30$85,00010%$0$93,500$15,00012%$119,720$1.197M
Product developerProduct5$150,00020%$0$180,000$15,00012%$216,600$1.083M
Scrum masterR&D4$160,00020%$0$192,000$15,00012%$230,040$0.920M

Pros: The benefits of a role-based planning approach is it is easier to manage than a named-based planning approach. This is because you only have to develop averages for each role and track the plan at the role level. Another benefit is it does not require obtaining salary data at an employee level.

Cons: The biggest drawback with this approach is it is less accurate than a name-based approach, and it can be difficult to reconcile when discrepancies arise between the plan and actual headcount.

Capacity-based

Capacity-based planning is prevalent in environments like call centers where each employee can manage a certain number of calls. In this type of environment, you will staff the organization with a certain number of people that achieves the capacity required to meet the anticipated needs of the business. Below is a simplified example of a capacity planning model one might use for a call center. In the below example, we have calculated how many calls each rep can handle in a week and how many calls we anticipate to receive in a week and then came up with a number of reps to staff. We would then apply our cost assumptions for each agent to develop our plan.

Pros: The main advantage of a capacity-based model is it allows you to staff your organization based on the anticipated needs throughout the year and adjust up or down your staffing based on the anticipated needs of the business.

Cons: Challenges with this model mostly center on being able to forecast your capacity needs accurately. Suppose you are substantially off in your assumptions. In that case, it can have a major impact on your P&L.

Project-based

Many companies, in particular professional services companies, build their budget based on anticipated projects. A professional services company might base its headcount plan based on the number of projects they anticipate working on during a given year. When building a headcount based on projects, time tracking software can become very helpful as it can provide information about how many people and how many hours have been spent historically on a project. Beebole allows you to track each employee’s time spent working for different clients and on different projects.

Pros: The benefit of this approach is you have built your hiring needs based on specific projects and if the needs for a project change you can update the needs for that project without having to update the rest of the plan.

Cons: Project based planning can be challenging to manage especially if you have a large number of projects. If every employee works on multiple projects and projects are short-term in nature it may not be realistic to use a project-based approach to planning.

How project time tracking software can help

Common watch-outs

No headcount plan, especially for a fast-growing company, is going to be perfect. The reality is some roles will be hired earlier than planned, some roles will be hired later, and some might never be hired. That being said, just because your plan will be wrong does not mean you should not strive to be accurate with all known assumptions (Current salary, bonus, rate, taxes, etc.) and make reasonable assumptions for all other parts of the plan.

As you build the plan, a few common things to watch for include:

Special bonuses

It is not uncommon, especially in a fast-growing company with immature processes, for someone to have a special employment agreement that includes a bonus that finance has not been informed exists. Make sure to validate this with the HR team.

Calendarization

For simplicity, it is common to take all the salary assumptions and divide them by 12, but in reality, there is often seasonality in headcount planning. Make sure you consider how seasonality might impact the monthly and quarterly forecasts before just taking each number and dividing it by 12.

Lack of collaboration

Make sure you do not just rely on HR for current workforce data but coordinate it with the department heads as it is not uncommon for the department head to be aware of mistakes in the data or changes that will be happening that the HR team does not have.

Hiring assumptions

Make sure the hiring assumptions are realistic for the organization as a whole. I have seen departments plan to hire more people in a month or a short time period than is possible given the resources of the organization. The business often wants to hire everyone tomorrow; it is your job to ensure reasonable assumptions are made for how fast the hires can be made.

As one builds the headcount plan, watch out for common mistakes that can derail the plan and create frustration and challenges later in the year when the budget is off track due to poor headcount planning.

Final thoughts on budgeting for and forecasting an accurate headcount

Headcount planning can be a real challenge and especially painful when you are trying to reconcile your data. But if you don’t get it right, the pain of explaining every moment that the variance is due to a headcount error is a lot more painful. I had a manager once who made a mistake on headcount, and every month the head of the department would remind us of that when we reviewed the budget.

For this and the many other reasons mentioned in the article, every company should be doing headcount planning annually to ensure the current and future needs of the company are met. What method a company uses for the hiring plan will vary by company and will often include a mix of approaches, depending on what is best for the different departments within the company.

The key to headcount planning is ensuring the right conversations are happening between finance, HR, and business leaders. Nothing is more gratifying for a company than realizing the effort spent on building a well thought-out and planned headcount is worth it. And that happens when it comes to fruition and helps the company achieve its strategic goals and its revenue plan. At the end of the day, nothing is more important than people—it’s the people that make or break a business. Spending time to ensure that you have the right hiring plan is a big part of any hyper-growth company achieving its targets.

The experts who have written or contributed to this article are independent from Beebole, and their contribution doesn't serve as endorsement for our company/tool or their past/present organizations, employers, or associates.
Paul Barnhurst is the founder of The FP&A Guy and a thought leader in the corporate finance space. His expertise lies in budgeting, forecasting, financial planning and modeling, report building, and business partnering.

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