How to Calculate Labor Cost for Your Business
By Allegiance Staffing
July 13, 2021
If you want to run a profitable business, it’s absolutely essential that you or whoever runs your finances must know how to calculate labor cost. When we say labor cost, which goes far beyond employee wages, there are many bits and pieces that can go unaccounted for if you don’t know to pay attention to them. If you want your business to grow, this is a crucial part of the process.
First, let’s talk a little more about why labor cost is important, and then we will dive into how to crunch those numbers.
Why You Should Care
For around the first five years of a business’s life, kinks are still getting worked out, and you’re figuring out what needs to happen to make a decent profit. Most business owners are continuously in ‘growth mode’, always working toward the next steps to make more money and keep the company thriving.
You should care about your labor costs because it helps you to:
- Set optimal prices that cover costs and maximize your profits
- Determine how many additional employees you are able to afford
- Calculate where your revenue needs to be to proceed with new growth initiatives
- Pinpoint leaks that are unnecessarily draining your earnings
- Monitor spending trends so you can flag potential fraud activity
- Move your way out of being involved in the day-to-day production and spend more time where you want to
What Makes Up Labor Cost
Your direct labor cost is a formula that allows you to get a complete view of how much you’re spending on labor. This includes wages, payroll taxes, overtime hours, employee benefits, and more. Once you determine your true labor costs, you can accurately set labor budgets and protect your cash flow.
Here are all of the different things to factor into your labor cost if you aren’t already:
Hiring and Recruitment
Labor costs start accruing even before officially hiring an employee. Promoting job openings, participating in job fairs, keeping your job openings page on your website updated, background checks, and more all cost your company money and should be incorporated into your labor costs.
This is a big one that people tend to overlook or not equate accurately. Research done by Training magazine found that U.S. businesses spend around $1075 training each new employee. Employees may have set training hours, but many people take longer than that to be as efficient and helpful as more seasoned employees, and that should be considered as well.
The most obvious and straightforward employee expense is what you pay them for their work. When calculating costs, make sure to use the same timeframe for all categories in your labor cost. The most common timeframe to use is the cost per year. So for employee wages, you would calculate the total cost of salaries or hourly wages you pay all of your employees annually.
Employee benefits make up roughly 30% of their cost, which is a pretty big chunk. Generally, the more employees you have, the less benefits will cost per employee. The most common benefits employers tend to offer their full-time staff are:
- Health insurance premiums
- Retirement contributions (401k)
- Paid time off (PTO)
- Supplemental pay (overtime)
Each person you employ adds additional taxes for your company. This is made up of:
- Federal income tax
- Social Security and Medicare taxes
- And unemployment
Social Security and Medicare are also taken out of the employee’s wages, but the employer also is responsible for matching the amount taken on top of that.
Overhead is usually thought of as costs to the company aside from employee costs. However, the amount of people you employ does have an effect on overhead costs, and that should be incorporated into the equation. For example, the more people you hire, the more office supplies, equipment, cell phones, and any other gear you provide will need to be purchased.
Aside from the usual costs covered above, you will also want to work in any other additional and one-time costs that come up. Some examples of what those might be are:
- Seasonal/temporary employees
- Contractors, freelancers, and consultants
Reliable Labor Cost Formula
Now that you know what to include, it’s time to add it all up:
- Total all of the expenses in each category for the year.
- Divide that sum by the number of employees you have to get the cost per employee.
- Break the cost down per hour by dividing the cost per employee by the number of hours worked per year.
We Can Help You Lower Labor Cost
While the above formula does work, employee costs are not always as straightforward as you think. Our Employee Cost Calculator helps you factor in the hidden costs of employees through temporary staffing. We take the headache out of the calculation by giving you a quick plug-and-play method along with a downloadable PDF of your results.
Also, consider using Allegiance Staffing to help you save. By using our expert staffing services, we can help you lower your labor costs by:
- Minimizing initial hiring expenses
- Reducing or eliminating turnover costs
- Reducing HR costs
- Minimizing training time and improving efficiency with temps
Want to know more? Give us a call today!