Why HR Matters for SMEs: The Real Costs of Getting It Wrong — and the Value of Doing It Right

Why HR Matters:

HR Is More Than Admin — It’s a Safeguards your Business

Many small and medium-sized enterprises (SMEs) view HR as a secondary function — something to worry about later, once the business is bigger. In reality, HR should be a priority from day one. It’s not just about contracts or staff handbooks; it’s about protecting your business from legal risks, managing people effectively, and creating a workplace where employees want to stay.

Relying on guesswork, outdated templates, or informal chats might work in the short term, but sooner or later, poor HR practices lead to serious and expensive problems. This blog explains why HR matters for SMEs, what can go wrong if it’s ignored, and how proactive management can save thousands in hidden costs.

Compliance Isn’t Optional — Even for the Smallest Employers

Employment law in the UK applies to every business, regardless of size. As soon as you employ someone, you’re legally required to issue a written statement of terms, pay at least the national minimum wage, and comply with legislation covering equality, working hours, sickness, and more.

Unfortunately, many SMEs fall into the trap of thinking the law won’t apply to them, or that being well-meaning is enough. But legal obligations don’t come with exemptions for small business owners, and employment tribunals rarely show leniency for ignorance or informal practices.

In fact, employment tribunal claims have risen in recent years, and the cost of getting it wrong can be substantial. A typical unfair dismissal case can result in a payout of around £12,000, and discrimination claims often cost far more. Even if you win, defending a claim can cost over £8,000 in legal fees.

What Happens When HR Is Overlooked

You don’t need to end up in a tribunal for poor HR to cost you money. Across the UK, SMEs lose thousands each year through poorly managed absence, overpayments, inconsistent performance handling, and high staff turnover — often without realising how preventable these problems are.

Sickness Absence: An Expensive Blind Spot

The average cost of sickness absence per employee is £835 per year (CIPD, 2023). Multiply that across a team of 20 people, and you’re potentially losing £16,700 annually to lost time, disruption, and overpayment. If absence isn’t being properly tracked or managed, the figure can easily be higher.

Businesses with structured absence processes — including return-to-work meetings, trigger points, and HR software — tend to reduce unplanned absence by 20 to 25%. That could save a business £3,000 to £4,000 a year

Payroll Mistakes and Overpayments

Manual HR processes or spreadsheet-based systems are prone to errors. Common mistakes include paying leavers beyond their notice, miscalculating statutory holiday pay, or failing to apply wage increases on time. These aren’t just operational headaches — they lead to lost revenue and potential legal consequences if employees are underpaid.

By putting in place structured payroll processes and linking them with absence records and employment contracts, small businesses can avoid these common and costly pitfalls.

Performance Without Direction

Many SMEs avoid formal appraisals, thinking performance issues can be addressed in casual chats or on the fly. But without clear job expectations, regular feedback, and proper documentation, underperformance is hard to challenge — and motivation can quickly fade.

Eventually, this leads to costly exits and replacements. Hiring a new staff member typically costs £3,000 to £5,000 in recruitment, onboarding, and training. Even worse, if you dismiss someone without following a fair process, you may face legal action.

Structured HR processes help identify performance issues early, provide improvement plans, and ensure that staff feel supported

Good HR Saves You Money — Here’s How

While HR is often seen as a cost, it should really be viewed as an investment. Effective HR practices not only keep you compliant, they actively improve your business.

A clear and well-managed HR setup can help you:

• Reduce unplanned absence and recover lost productivity
• Prevent payroll errors and wage overpayments
• Boost staff morale through fair, consistent performance management
• Retain good employees by offering a professional and supportive working environment
• Avoid legal claims and reputational damage from mishandled dismissals or grievances

For example, using a simple HR platform like Breathe HR allows you to track holidays, manage absences, log performance reviews, and store documents securely — all in one place. These tools take much of the admin off your plate and drastically reduce the likelihood of small issues snowballing into big ones.

What Every SME Should Have in Place

At a minimum, every employer — even if they only have a few staff — should have:

• A written employment contract or offer letter tailored to the role
• A basic staff handbook that outlines key policies, such as absence, disciplinary, grievance, and equality procedures
• A reliable method for recording holiday and sickness (this could be spreadsheet-based at first, but HR software is strongly recommended as you grow)
• A clear process for managing underperformance, including setting expectations and reviewing progress
• Access to up-to-date legal and HR advice, whether internally or via external support

Many small business owners find that once they start documenting their policies and using simple systems, it becomes easier to manage people fairly and confidently.

Why SMEs Delay HR — and Why That’s a Risk

It’s understandable why small business owners put HR on the back burner. There’s often a perception that HR is only needed for large organisations, or that it’s too expensive or time-consuming to set up properly. But most HR issues aren’t costly because you have HR — they’re costly because you don’t.

Waiting until something goes wrong (a staff dispute, a grievance, or a claim) is when most businesses realise the importance of HR — but by then, it’s often too late to avoid the financial hit.

The real cost of poor HR isn’t just tribunal claims or fines. It’s:

• Time lost dealing with conflict
• Team morale affected by inconsistency
• High turnover from staff feeling unsupported
• Productivity dips when absence isn’t managed

How SMEs Can Manage Their HR — And Why Outsourcing Can Be a Smart Move

There are two main ways SMEs can manage their HR: doing it in-house (the DIY route) or outsourcing to a specialist provider.

DIY HR

The DIY approach may seem cheaper at first — using online templates and managing processes manually — but it often costs more in the long run due to errors, inefficiencies, and compliance risks.

Outsourced HR

Outsourced HR services, on the other hand, give you access to expert support, up-to-date templates, and cloud-based systems for a predictable monthly fee. For as little as £150–£300 per month, many providers offer compliant contracts, staff handbooks, absence tracking, performance tools, and access to legal advice — giving you peace of mind and saving hours of admin. For busy SME owners, outsourcing is often the most cost-effective and time-saving way to stay legally compliant while focusing on running the business.

Final Thoughts: Take HR Seriously — Before You Have To

HR doesn’t need to be complicated — but it does need to be consistent, compliant, and proactive. For SME employers, it’s not just about avoiding legal trouble. Good HR keeps your team engaged, your processes efficient, and your focus on growing the business instead of putting out fires.

Whether you choose to build internal HR capability or get support from an outsourced provider, the most important step is taking it seriously. The cost of not doing so is far higher than most SMEs realise — and the savings from even modest improvements can be substantial.

Need help getting started with HR in your business?

KeyHR offers practical, affordable HR solutions for SMEs — including contracts, staff handbooks, software, and expert advice to keep you compliant and in control.