Workforce Management What Are Labor Costs? A Comprehensive Guide By Madhurima Dey Workforce Management No comments August 2, 2024 You may want to fully comprehend labor cost and how it affects you if you work in HR, finance, auditing or management. You can calculate this value by adding the prices of all staff wages and benefits. Further, you can leverage reliable workforce management software or accounting software to automate labor cost calculations. Compare Top Workforce Management Software Leaders What This Article Covers What Are Labor Costs? What Impacts Labor Costs? Calculations Benefits Reducing Costs In Conclusion Let’s get started! What Are Labor Costs? Labor costs are the total wages, incentives, taxes and insurance your company provides employees. One can break down labor costs into direct and indirect costs, where direct costs include wages for workers who produce goods and indirect costs include employees who preserve industrial machinery. You can usually subdivide labor costs into two components — fixed and variable: Fixed: They have generally contracted charges but can also include predictable indispensable costs like healthcare benefits and pension schemes. Variable: These costs rise and fall in response to multiple factors such as product demand and market circumstances. Labor mainly falls under the fixed cost category. It is viewed as a variable cost when you only pay for the number of hours employees worked on an as-needed basis, which is typically the case when employing temporary or contracted labor or part-time workers. It varies with production and your employment methods. Get our Workforce Management Software Requirements Template What Impacts Labor Costs? Labor costs vary by industry. However, some commonalities help businesses determine how much labor costs. Apart from gross wages, the cost of labor includes your social contributions (welfare benefits, wage stagnation, retirement benefits, health care benefits, severance, etc.). Whether mandatory, customary or optional, a net of exclusions, particularly cutbacks in social security payments, are a part of labor cost. The total cost of skills courses (apprentices tax, contributions to vocational education financing, etc.), wage costs and other employment-related taxes are essential components of labor cost. Not only that, but it also covers a net of incentives aimed to enhance employment and company earnings, such as the tax rebate on competitiveness and jobs (CICE). Finally, they also include costs associated with staff employment, such as recruitment spending. So, when calculating labor costs, consider the following: Wages Overtime Bonuses Payroll taxes Insurance Benefits Sick days Vacation days Health care Meals Supplies Transport stipends Training Consider your costs for everything mentioned above, and you’ll be closer to determining how much labor costs. Get our Workforce Management Software Requirements Template Calculations There are several methods for calculating labor costs. Basic Formula The basic calculation below suggests that the expense of benefits and payroll are broken into an average hourly rate and that the business has no added benefits or payroll tax expenses. Labor Cost = (Total Sales * Labor Percentage) / Hourly Average of Employee Salaries Formula for an Employee’s Average Hourly Cost First, compute gross pay (gross pay = hourly pay rate x estimated annual hours worked). Add absenteeism to your calculation (employees are entitled to vacation and sick days; therefore, use industry or business averages to evaluate sick time and breaks you should include). Include other external costs in your calculation (allow for additional financial information to track any other employee expenditures, such as benefits expenses). Determine the actual hourly labor cost (overall hourly labor cost = yearly payroll labor cost / new annual work hours). Labor Cost Percentage Formula The equation for determining labor cost as a percentage of revenue is as follows: Labor Cost % = (Total Labor Cost / Total Sales) x 100 And here’s the formula to determine labor based on a percentage of operational costs: Labor Cost % = (Total Labor Cost / Total Operating Costs) x 100 Get our Workforce Management Software Requirements Template Primary Benefits Accounting and finance experts actively calculate labor costs as it is valuable for a business’s success. Understanding labor costs and how to calculate them is beneficial for various purposes, including the following. Manage Costs If you’re planning to lay someone off or an employee has given notice, you can estimate future costs more accurately by excluding that employee’s labor costs or accounting for a replacement employee’s labor costs. This helps you predict costs more accurately as your workforce changes. Outsource Operations Before outsourcing any operations to a vendor, a manager should understand labor costs to assess the company’s amended cost structure. Ideally, you want to outsource operations to lower your labor costs. Having a solid grasp of where your costs are currently and how outsourcing will impact those costs can help you decide if it’s financially beneficial. Negotiate Union Regulations If employees are unionized, leaders must consider the labor costs of negotiating positions of each employee to calculate the general business expenses and save excess labor costs. Transfer Costs Employers can minimize labor costs in a few cases by relocating the cost straight to the customer. Tipping, for instance, is welcomed in the hospitality sector, allowing businesses to keep labor costs low. Compare Top Workforce Management Software Leaders Reducing Costs Businesses should reduce their labor costs as long as they are not jeopardizing employee satisfaction or the well-being of employees. Here are some strategies you can use to reduce your ever-increasing labor costs: Monitor each employee’s working hours to detect any unnecessary overtime. A few states have extremely costly overtime laws. Pay employees based on when they start their work, not when they clock in. Those extra five, ten or fifteen minutes add up. To minimize missed shifts, provide non-monetary incentives. Missed shifts increase labor costs because they can drive another employee (who will make up the absent employee’s shift) into overtime. Cross-train your workforce for better time management and so work doesn’t go undone when an employee is absent. Examine past sales and traffic data, and reduce scheduled labor hours on typically slow days. Consider integrating vacation and sick leave into a single PTO bucket. Try three weeks combined if you give two weeks of paid leave and two weeks of sick leave. Using checklists, you can keep all of your employees productive and on-task, thereby optimizing employees’ working hours. Implement ongoing training to increase employee productivity. Maintain an up-to-date employee training manual as well as an SOP manual. The higher the productive output of your employees, the lower your labor costs will be. One of the simplest ways to cut labor costs is to make employees more engaged and productive. Recruit the right people. It saves money on labor if you recruit efficient staff. A large part of lowering labor costs is optimizing employee management. The better employees are at their job, the better your company runs. This means increased productivity, fewer days off, lesser wastage of working hours and improved execution. Compare Top Workforce Management Software Leaders In Conclusion Labor costs are essential to core business metrics such as profit maximization. It’s no surprise, then, that comprehending and analyzing this financial variable is critical to the success of your business. In this article, we tried to explain the intricacies of labor costs, showed you how to calculate them, and provided tips for controlling labor costs within your business. Purchasing software can help you monitor and significantly reduce your labor costs. If you’re in the market, check out resources before you make any purchasing decisions. First, build your workforce management software requirements. Once you know what you need, check out our comparison report to narrow down vendors. How do you manage labor costs? Please share your thoughts in the comments section below. We’re looking forward to hearing from you. Madhurima DeyWhat Are Labor Costs? A Comprehensive Guide08.02.2024