The Dangers of Annual Leave Balances on Cash Flow Management
Cash flow problems are the leading cause of business failure for small businesses in Australia, and sometimes the causes of these problems aren't obvious. Did you know that letting your staff build up large annual leave balances could put your future business cash flow at risk?
If you have a large annual leave liability on your balance sheet, it might be time to rein it in. Read on to find out how, and ways to mitigate the risk for your business.
The problem of unused leave balances
The National Employment Standards in Australia specify that full-time and part-time employees are entitled to four weeks of fully paid leave. Some occupations have more.
However, it’s a fact that many Australians don’t take their full four weeks each year for various reasons. Employees are entitled to their full leave balances upon leaving the business. This means the more the leave balances build up, the higher the risk of having to pay out a large lump sum if the employee decides to leave your business.
Allowing excessive leave balances to build up can lead to significant cash flow troubles, particularly if you have large staff numbers in your business. It can also be a problem if you have a lot of staff all requesting long breaks simultaneously, both from a cash flow and staff morale problem. If you approve all the leave, it must be paid, and business productivity may suffer. On the other hand, if you don’t approve everyone’s full request for extended leave, it can seriously affect staff morale and your work relationships.
Fair Work Australia defines excessive annual leave accruals as being more than eight weeks for ordinary employees and more than ten weeks for shift workers.
The potential impact on cash flow
To understand the potential cash flow impact, consider this example business with 10 employees:
- 10 employees
- Each have a salary of $75,000 per year
- Each employee has accrued 6 weeks of annual leave
With 6 weeks of leave accrued by each of the 10 employees, the business has an approximate leave liability on the balance sheet of $86,500.
Let’s say 3 of those employees resign in the same quarter. The business is required to pay almost $26,000 of accrued annual leave to these employees. If these employees need to be replaced, add in potential recruitment and onboarding costs into the equation and this becomes a significant unexpected outflow of cash.
The hidden costs that come with annual leave liability
A common component many businesses often leave out is the add-on costs to the annual leave liability. It's a good idea for cash flow management to consider the increased liability of payroll related costs such as payroll tax, super, and WorkCover insurance.
In addition to base wages, employers may be liable for:
- Superannuation (currently 12%)
- Payroll tax (approximately 4.75%, depending on state thresholds)
- WorkCover insurance (approximately 0.25%)
Together, these can add roughly 17% on top of the leave liability.
Using the earlier example: $86,500 + 17% = $101,205
That means the true leave liability exposure could be closer to $101,205, not $86,500.
Note the 17% is largely due to the 12% super, payable on annual leave taken and cashed out, but is not payable when employees cease to work for you. Workcover and Payroll tax is payable on all three scenarios.
Don’t forget about long service leave
Long service leave (LSL) is another leave liability that’s often overlooked until an employee resigns or becomes eligible. Unlike annual leave, LSL accrues over many years and can result in a much larger payout per employee when it falls due. In most states and territories, LSL vests after 7 to 10 years of continuous service, meaning the liability can quietly build in the background.
From an accounting perspective, LSL liabilities are often adjusted for:
- The probability that the employee will reach vesting
- The present value of the future payout
However, once employees approach eligibility, the potential cash impact becomes far more immediate. For businesses with long-serving staff, LSL can represent a significant future cash outflow if not planned for properly.
LSL rules vary by state, including vesting periods and payout conditions, so make sure you check the Fair Work Ombudsman for the rules relevant to your state or territory.
How you can keep your staff leave balances under control and maintain positive cash flow
Thankfully, there are a variety of strategies you can use to encourage your team to take their full leave entitlements each year. They include:
- Negotiating with staff members to pay out excessive amounts of unused leave. This reduces the employee’s leave balance as they are paid out rather than having the leave owing to them. You’re in control of when you pay them out, so you can plan to do it when it suits your cash flow.
- Encouraging your staff to take regular days off to reduce their leave balances to acceptable levels (such as every Friday or every Monday (periodically), if that’s practical).
- Directing your staff to take leave if they have built up excessive amounts. You must follow Fair Work Australia’s guidelines to ensure your legal compliance with workplace laws if you take this approach.
As your employees' annual leave entitlements accrue, try to keep an eye on how much money you would need to pay them if they gave notice tomorrow. Being aware of how much cash you need to cover any unexpected situations can help you develop a plan around how to manage money shortages. Undertaking a cash flow analysis is great, but you also need to be aware of contingencies like annual leave entitlements. Consider things that may not appear on your latest cash flow statement.
Create a leave policy
A leave policy helps ensure employees are aware of your expectations regarding leave, and when followed, helps you keep leave balances in check.
Consider the following checklist when creating a leave policy for your business:
Leave management checklist
- Set clear policy thresholds
- Communicate a maximum annual leave balance (e.g. no more than 6 weeks accrued)
- Align thresholds with Fair Work guidance on "excessive leave"
- Document thresholds in your leave policy and employee handbook
- Monitor leave balances regularly
- Review leave balances quarterly using payroll or accounting software
- Identify employees approaching policy limits
- Track both annual leave and long service leave liabilities
- Have conversations early
- Initiate a conversation when an employee reaches 4 weeks of accrued leave
- Discuss planned time off for the next 6 to 12 months
- Encourage proactive leave planning rather than reactive payouts
- Encourage leave to be taken
- Prompt employees to take regular leave throughout the year
- Consider requiring a minimum leave block, such as one continuous 2-week break per year
- Where balances become excessive, follow Fair Work guidelines to direct leave if necessary
- Plan for the cash flow impact
- Include leave liabilities in cash flow forecasting
- Model "worst-case" scenarios (e.g. multiple resignations in one quarter)
- Ensure buffers or funding options are available
- Manage excessive balances strategically
- Consider paying out excess leave (where legally permitted and agreed)
- Schedule payouts during stronger cash flow periods
- Avoid large, unexpected lump-sum leave payouts
- Review Long Service Leave exposure
- Track long service leave accruals
- Understand state-based LSL rules and vesting periods
- Factor upcoming LSL eligibility into long-term cash planning
- Review annually
- Review leave policy annually
- Update thresholds as the business grows or staffing changes
- Re-communicate expectations to staff and managers
Making annual leave a normal part of work
While a leave policy is a solid way to set expectations, it's important to build the practice of taking leave into the culture of the business, so holidays become a natural part of the workplace, rather than something that needs to be enforced.
To build a healthy culture around annual leave, you can lead by example and enjoy regular time away from work, and positively frame leave as something that is encouraged rather than punished. This cultural shift can help to keep leave balances in check while also strengthening employee well-being.
How to calculate leave liability
If you're using accounting software like Xero or MYOB, the program will keep a record of the current leave balance. It's as simple as running the Xero Leave Balance Report or viewing the employee entitlement balance in MYOB.
To work out the leave liability (the dollar figure you'd need to pay if the employee left), you can view the Leave Liability report in your Xero or MYOB account.
To keep leave liability top-of-mind, you can periodically check these balances to avoid any cash flow surprises.
How to manually calculate leave accrual and leave liability
To manually calculate leave liability, there are two important steps:
- Calculate how much leave accrues each pay period
- Convert the accrued leave into a dollar value
Step 1: Calculate annual leave accrual
Annual leave accrual = Annual leave hours per year ÷ number of pay periods per year
Example
For a full-time employee working 38 hours per week, the annual leave entitlement is:
4 weeks × 38 hours = 152 hours per year
If the employee is paid weekly, there are 52 pay periods per year:
152 ÷ 52 = 2.923 hours
This means the employee accrues 2.923 hours of annual leave each week.
Step 2: Calculate the leave liability
To determine the leave liability, multiply the accrued but unused leave hours by the employee's current hourly base rate, then add any applicable costs (such as leave loading).
Leave liability = Unused leave hours × hourly base rate + leave loading if applicable
Example
Unused annual leave balance: 228 hours
Hourly rate: $40
228 × $40 = $9,120
If leave loading applies at 17.5%:
$9,120 × 17.5% = $1,596
Total annual leave liability: $10,716
Adding in approximately 17% for superannuation, WorkCover and payroll tax, the leave liability sits at about $12,537.
What to do if you’re experiencing cash flow problems
If your business doesn't have enough cash to keep up with annual leave or any other operating expenses, financing options like invoice finance can help. Unexpected leave payouts can be large and lumpy. With an active Invoice Finance facility in place, businesses can draw funds immediately from invoices that will be paid by their clients in the future. This process accelerates your cash flow rather than taking out a loan to cover leave expenses.
Consider what you would do if a long-serving employee leaves the business, triggering a large annual leave payout. Most businesses don’t have large sums of cash sitting around to cover expenses like this. With invoice finance in place, you can access cash from those unpaid invoices immediately to cover the payout.
Working capital finance is a tool to help your business move forward without affecting your working capital.
The bottom line
Managing the holiday leave balances of your staff effectively is an important business cash flow management tool and can help to significantly reduce your risk of being caught out owing thousands in annual leave. By keeping on top of your potential cash outflows, you can work towards maintaining a positive cash position.
