When you pay employees, it helps to know what the cost is to you on an annualized, or yearly, basis. This figure is important for figuring your profits and for calculating your taxes. However, the terms "annual" and "annualized" have specific meanings in employment law, as do the terms "earnings" and "salary." You need to be aware of how they are used before you use them with your employees.
An employee may earn hourly wages or part-time compensation. When you calculate what this employee will cost you an a yearly basis, you need to annualize the wages. That means you multiply one week's wages by the number of weeks the employee would work in a year, or multiply a month's earnings by the number of months the employee would work in a year. The catch is that the employee may not actually work all of those weeks or months. The annualized figure gives you an idea of what the employee would earn per year if she worked the same number of hours each week or month for the entire year. Example: if you pay an employee $1,000 for one month, then that figure represents annualized earnings of $12,000 per year. If the employee quits mid-year, you can say that you were paying her at an annualized rate of $12,000 per year, although you only paid her $6,000.
Annual earnings is the actual amount an employee earned in a year. It is figured retroactively or after the earnings have been paid. This differs from annualized earnings as it is not an estimate of what may happen; it is a record of what did happen. In the earlier example, the employee who quit had annual earnings of $6,000, half of what the annualized earnings rate indicated she would have earned if she had stayed all year.
An annualized salary is useful for employees who do not work the full year, such as teachers, and for employees who work part of each year on a salaried basis. Annualization is the process of spreading the payments to the employee out over the entire year, though the salary is only earned for part of the year. This gives the employee a steady paycheck when he is not working.
An annual salary is the amount you agree to pay an employee to work for you for a year. The employee can expect her gross income to match the salary you are paying, unless she works overtime. The monthly paychecks are identical, because they are calculated to add up to the annual salary at the end of the year. Annual salary refers to an agreement between the employer and the employee regarding an exact amount of compensation for one year.