How To Calculate Labor Cost: A Step By Step Guide

With some tinkering, you can ensure every dollar contributes to your business goals. Your workforce is your greatest asset—but haphazard labor budgeting can weigh your organization down rather than how to calculate direct labor cost per unit boost profits. Take your learning and productivity to the next level with our Premium Templates. Access and download collection of free Templates to help power your productivity and performance.

‍Step 1 Determine Gross Annual Wages

Wages and salaries averaged $30.76 per hour worked, accounting for 70.3 percent of employer costs. Benefit costs averaged $13.02 per hour worked, and accounted for the remaining 29.7 percent. Cross-train employees to perform multiple roles for greater flexibility in managing workforce resources. You will need to budget for upskilling and cross-training, but an agile team with diverse skills will strengthen productivity, improve morale, and optimize labor resources. Likewise, in the case of shifts, your employees’ hourly rates may vary according to the type of shifts they work. Let’s analyze some of them to better understand why calculating labor cost is so important for any company.

The legal framework around labor compensation

Employees that oversee operations but aren’t involved in the product, like a plant manager, are part of manufacturing overhead costs rather than direct labor costs. Imagine an employee hourly rate of $15/hour, including all direct labor and indirect labor costs, and a service that takes 3 hours to be completed. The direct labor hourly rate, also known as the labor rate standard, includes the hourly pay rate, fringe benefits costs and your portion of employee payroll taxes. Calculate the hourly value of fringe benefits and employee taxes by dividing that amount by the number of hours worked in the pay period. The variance is obtained by calculating the difference between the direct labor standard cost per unit and the actual direct labor cost per unit. If the actual direct labor cost is lower, it costs lower to produce one unit of a product than the standard direct labor rate, and therefore, it is favorable.

• Finally, assess the difference between the budgeted (standard) labor costs and actual expenditures.
• Allocating the majority of hours to a few workers can lead to a small group of workers being paid overtime salaries while other workers are underused.
• These technological advances empower businesses to manage direct labor costs with precision, reducing unnecessary expenses and improving overall productivity.
• You can use this information to identity and investigate why your actual costs are higher or lower than your standard direct labor per unit costs.
• So if a company currently has 100 employees and ten leave during the year, the separation rate would be 10%.

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While direct labor cost relate solely to the salaries employees get paid, indirect labor cost are all the other benefits we mentioned above. Indirect labor costs can significantly impact a company’s profitability, and administrative tasks make up a large chunk of these costs. If your employees are efficient, they’ll create more products during their working hours, so you’ll be getting more bang for your buck with your labor costs.

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We also understand that keeping track of costs, creating optimized schedules, and maximizing efficiency are easier said than done. As of April 2022, in the United States, the average hourly labor cost is 24.82 USD/hour. Manufacturing costs are the costs involved in producing a product, including the costs of materials, direct labor, and overheads. Indirect costs related to lost opportunity can make your company’s total costs and profitability harder to calculate. In short, labor cost in manufacturing industry is the total amount spent on employees by your company. Businesses often set a standard cost and compare it against actual expenses to track performance.

Indirect costs also include opportunity costs, which indicate the money lost because a particular aspect of your business isn’t running as it should be. If a three-person auditing team spends a full 40-hour work week auditing a client’s inventory, that equates to 120 hours of labor on that job — three auditors times 40 hours worked each. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. This method accounts for the number of employees who left and the number of new employees divided by the average number of employees during the period.

Percentages vary significantly by industry – companies providing services might have a labor cost percentage of 50 percent or more. Most production companies will try to keep their labor cost percentage under 30. Successful businesses constantly evaluate how much employees cost and seek to strengthen operational efficiency. Reduced labor costs improve your bottom line and free up resources for other strategic initiatives, like improved benefits packages or better tools. For example, suppose employees earn $30 per hour, and you pay out $300 in benefits and $150 in taxes for every 40 hours of work.