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Calculating the True Cost of Labor

| Sep 22, 2014

As a contractor, determining your prices can be difficult. If you're new to the industry, you may be tempted to guess at your costs and quickly add a markup.

While guesswork may lead to a profit on a few jobs, over time, uneducated estimates will lose you money because you haven't properly accounted for all of your financial burdens.

To be able to accurately track your business's costs and profits, you must be able to calculate your true labor costs, which is how much you spend to send one of your employees to work. Without knowing the actual cost of labor, you could lose out on thousands of dollars each year. It only takes being a few dollars off for each hour of each employee's work to add up to a significant detriment to the business's bottom line.

WHAT IT IS AND ISN’T

Labor costs are hard to pin down, but an accurate sum will account for the total direct and indirect costs an employer incurs when paying his or her employees. It isn't just the employees’ hourly wage. Additionally, you shouldn't get labor costs confused with the billing rate. The labor cost will be significantly more than the employee's hourly wage, but still less than what is billed to the client.

WHAT GOES INTO TRUE LABOR COSTS?

In addition to the employee's hourly wage, the cost of labor will include the employer's financial liability for state and federal payroll taxes, workers’ compensation and liability insurance policies, employee benefits, paid time off, retirement plan contributions, training expenses and more. If you supply tools, equipment or safety gear to your employees, such as work trucks, gas and cell phones, the costs of purchasing and maintaining these things will also be added to the cost of labor.

The fees that are part of labor costs can vary for each business. All businesses will have taxes and insurance policies to account for, but various amounts of equipment and travel make each employer's calculation unique.

HOW DO YOU FIGURE THESE COSTS OUT?

A business owner must contemplate, and work with an accountant, to determine each financial responsibility that is based on labor and how it applies to individual workers. It may take time to determine how much should be applied to labor costs, and it's important each year to re-evaluate labor costs to ensure they're as accurate as possible.

FACTOR IN YOUR LABOR UTILIZATION RATE

After the many parts of your labor cost have been determined, you have to figure out the amount of time you're paying each employee to work in the field and the amount of time you're paying the employee when he or she isn't working, such as when he or she is in meetings or driving to and from jobs. No employee is billable 100 percent of the time, and you need to know your utilization rate to determine the actual labor costs.

Your labor utilization rate equals the total number of billable hours in a year divided by the total number of hours you pay each year. If you have an employee who is only billable 70 percent of the time they are working and your labor cost is $60 per hour, divide the hourly cost by the utilization rate to find your true hourly cost ($85.71).

Without understanding and calculating the true labor cost, employers are likely to lose money. It could even lead to a point of spending more than you make in a year, which can be quickly devastating to a business. Depending on the financial burdens of the employee, a worker who makes $20 an hour may cost the company $70 to $80 an hour.