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How to Calculate Labor Cost (And What Most People Miss)

January 28, 2020 | Staffing Blog

Offering a great value to customers at a competitive rate is a major objective of any thriving business. This natural goal must be balanced with ensuring enough cash flow to meet all of the practical expenses to remain operational. Labor cost is one of the largest annual costs of any business that must be considered.

In some industries, labor costs make up a majority of a company’s total budget, sometimes up to 60-70 percent. However, many business owners do not know how to calculate their true labor costs. Therefore, they do not know what they can afford as it relates to hiring the best candidates to fill vital positions.

To be competitive in today’s market, business owners, managers, and HR leaders must master the concepts of true labor cost, including areas that are often overlooked. Educate yourself on how to calculate these costs and find out how Allegiance Staffing can assist with understanding labor costs and setting effective billing rates.

Steps to Calculate True Labor Cost

Be sure to know the true cost of your employees. Start by carefully considering all of the costs in selecting, training, and developing your employees. Consider these steps:

1. Research and calculate the major costs associated with employees in addition to their wages.

One of the largest considerations is the amount of tax revenue needed. Various taxes include Social Security and Medicare taxes through the Federal Insurance Contributions Act (FICA) and for unemployment taxes through the Federal Unemployment Tax Act (FUTA).

It is much better to overestimate for taxes rather than underestimate, which would cause a shortfall. Navigating payroll taxes is complex and is best completed with the help of an accountant.

2. Calculate the expense of offering health insurance.

Health insurance plans vary widely, but all include some level of contributions by the business itself. Seek expert guidance in providing plans that support the needs of your employees while keeping your overall budget intact.

3. Review the costs of operating the buildings and equipment at optimum capacity.

After considering taxes, insurance, building and equipment maintenance and other operating expenses, you have calculated the overhead of your company.

4. Account for gross wages paid to each employee.

Add gross wages to the total cost of these related expenses and divide by the number of hours the employee works each year. (Paid vacation and sick time are large factors to be considered in the calculation of gross wages.)

The cost of labor is the sum of each employee’s gross wages in addition to all other expenses paid per employee.

Total Labor Costs That Companies Often Miss

Labor costs are challenging to anticipate. There are both constant and variable costs, and because of this, several factors are often overlooked. It is best to recognize and identify as many hidden expenses as possible to help calculate your true labor cost.

  • Direct costs are generated by regular, often salaried, employees.
  • Indirect costs relate more to short-term employees who assist during times of peak production or need.
  • Maintenance and supervision of all workers must also be considered.

Another consideration is the costs associated with an employee’s ability to create revenue for the company. These overlooked expenses include uniforms, cell phones, vehicle expenses, and training, and they should all factor into your true labor cost.

From a production standpoint, there are other costs such as rework if a product needs to be re-done or fixed, plus scrap cost, which includes materials that needs to be altered to better align with the customer specs.

All of these employee-related expenses affect the bottom line of any business. Be sure to review every angle of running your business, and uncover as many hidden costs as possible.

Good Estimating is Investing

The need for accurate estimates of operational expenses cannot be stressed enough. Developing an effective method for accurate estimation is an investment in your company’s future.

Consider using a labor burden calculator to make your estimated rate as close to your actual rate as possible. Only then can the most profitable, practical rates be established.

Allegiance Staffing offers an effective process by developing a customized labor strategy for your business. Our experience makes us highly-skilled in finding the most cost effective solutions for your needs. This strategy includes a unique, highly-effective cost calculator.

Our Total Cost of Ownership Calculator helps factor in the hidden costs of employee staffing, especially in the temporary staffing that is needed at times. These factors include: temporary pay rate, markup costs, hours allowed, overtime costs, rework cost, scrap cost, and client penalty cost.

For our clients, Allegiance is dedicated to monitoring key performance indicators (KPIs) such fill rate percentage, overtime spending and actual labor costs, turnover, attendance, and labor as a percentage of operating costs.

At Allegiance, we seek the highest cost savings potential, then develop a plan that is customized to your needs. This process results in a greater use of time for employees and an increase in profit for employers.

Use the Allegiance employee cost calculator to find your true labor cost. Then, contact Allegiance to discuss a labor solution to help your company thrive.