Because payroll is often a small business's biggest expense, it's inevitable that you'll have to look there if you need to cut expenses during tough times. But cutting jobs and showing loyal employees the door is a miserable (though sometimes unavoidable) prospect. (For more information, see Nolo's article How to Lay Off Employees.) So before you take that big step, think about the less drastic option of cutting back employee wages, hours, and perks. It's no picnic to cut benefits or pay -- but it might let you avoid taking the even more painful step of laying off people you work with every day.
Examine every check your business writes. If your business is in trouble, you've probably canceled most employee extras, from company-paid cars, parking spaces, club dues to the daily newspaper, and bottled water. If you still have them, now's the time to cut.
Benefits should be the second place you look to cut employee costs. For example, if your business matches your employees' contributions to a 401(k) plan up to $1,000 per year or offers other generous benefits such as paying health club memberships, alternative wellness programs, or a pricey dental plan, seriously consider eliminating them. Although painful, when times are tough it's better to cut most benefits rather than lay off people. The one big exception is your medical plan. If you provide one, do your best to keep it, even if you have to cut your premiums by raising employee contributions and copays.
In bad economic times, when jobs are scarce, it's usually possible to cut pay and not lose employees. The first person to take a pay cut should be you (and if your spouse works for the business, both of you). Even if your compensation is already modest, so that cutting it won't save much, trimming your own salary is sure to get employees' attention -- and their respect -- in ways a dozen dire financial pronouncements never will. Next, sit down with any well-paid employees to help them confront the need to voluntarily accept similar reductions. Depending on pay levels and other circumstances, a cut of 10% to 20% might be reasonable. Be very reluctant to cut the pay of people at the bottom of your scale. Not only is this the decent thing to do, it helps you keep experienced employees who, if forced to take less, would probably look for another job.
Another way to spread the economic pain while saving jobs is to cut the work week. For example, going to a four-and-a-half day work week saves 10% of payroll; a four-day week saves 20%. Similarly, putting a freeze on overtime hours will save you money. The good news is that if your employees are highly motivated to see your business through to better times (and they appreciate the fact that the cuts avoid or reduce layoffs), the change won't significantly reduce overall productivity.
For more information managing your company's salary expenses, see Save Your Small Business: 10 Crucial Strategies to Survive Hard Times or Close Down and Move On, by Ralph Warner and Bethany K. Laurence (Nolo).