How To Calculate Labor Cost?

This article provides information on the importance of understanding how to calculate the labor cost and its significance for business.

How much does it cost to employ someone?

Shifting from being a business owner to an employer can be tricky. It is a serious thing because your employee relies on you to get paid for every week or month. If you are getting a helping hand, you should mind that it is not only the salary that you will be paying because there are other employment costs that you should consider.

Employers pay more than just the salary of their employees. But before you determine the actual cost there are some variables that you need to consider. It is a complex thing where you have to be careful and mindful of other things like location, type of business and the industry your business belongs to.

What is the cost of labor?

The cost of an employee is considered as his or her wage plus the other related expenses like state payroll taxes, health benefits and taxes, insurance, time off fees, and meals.

There are two types of cost of labor, direct and indirect or the overhead costs. The wages of the employees who are involved in the production of the product are the direct costs while the support labor like the maintenance man for the factory equipment is the indirect costs.

The price of the goods or services may change or shift from their real cost and profits will falter if the labor rate is not properly managed or evaluated.

The manufacturer sets the price of the product. The price should include the labor fees, material, overhead, and total overall costs incurred. No expenses must be left out as if there is, it will mean the profit will be lower than the expected. If there is a decline in the demand for the product, the manufacturer or the company should reduce the production cost in order not to lose profit. To do that, the business can do cost cutting such as reducing the manpower, increasing productivity or cutting back on all other factors in the production expenditures.

What is the computation for the labor cost per hour

To calculate the cost of labor per hour is getting the sum of the gross wages and related expenses such as the yearly payroll taxes and yearly overhead, then divide it by the total number of hours worked by the employee in a year. This process is also used to find how much the employer spends in hourly rate for their employee costs. For longer labor cost success, an app integration or employee time sheet should be considered.

What is overhead?

Overhead includes the fees you pay that are not included in labor costs such as the building costs or rents, taxes of the property and utility bills. It represents the average cost of employee benefits. They can be determined monthly or annually according to your business’ needs. To calculate, divide the total overhead from the yearly expenses by the number of workers.

While if you want to know the billable rate, determine the hourly wage of your worker and add it to your amount of profit. Then the sum should be divided by the number of hours worked by the employee for a year.

How to calculate true overhead rates

Understanding how to calculate the overhead is one way to learn what to charge or how a business can remain profitable. If you do not include the cost of overhead can also mean that you are losing money for the reason that you are under-billing your clients.

Direct labor costs

Labour Cost is the overall total cost of all employees that are involved in operations, from preparations to quality inspection.

Labor cost is the most important part of the business’ expenditures. It is divided into 2 types, direct labour, and indirect labor costs. Direct labour pertains to skilled while indirect is into unskilled labour. Direct labour means the total cost that involves in producing the product. These are the wages of the workers in the production department of the company. Another cost is the additional expenses spent on the employees’ payroll taxes, annual fund contribution paid by the employer, employee insurance. Other companies consider these costs as production overheads.

It is incurred in the manufacturing area to keep the operation working efficiently. Delays can increase the period of operation rather than the amount of the work done. The delay costs associated with the labor are considered a form of overhead cost. This cost of labour can be managed if the field of operation is fully supervised and controlled.

The Differences Between Direct and Indirect Costs of Labor

Let’s say a furniture company that is planning to price its product. So the direct labor cost is the expenses that are related to the production. So the company is paying for the workers who control the equipment that cuts wood, these costs are direct costs. While the indirect labor costs are the labor costs rendered by employees who provide security to the factory or warehouse, this means this cost does not exactly relate to the process of the production.

Examples of Fixed and Variable Costs of Labor

Labor cost has two classifications, fixed cost, and variable cost. From the furniture business view, the expenses paid to the workers who manage the equipment is the variable, which changes depending on the level of production. The decrease or increase in the variable cost is dependent on the amount of production. Fixed labor cost is the expenses paid to the service contracts which is a long term fee. For example, the furniture firm signed a contract with an outside service provider for equipment maintenance and repair, and this is a fixed cost.

Significance of Labor Costs

Labor cost management is a vital element of the labor costing system. A business can keep running and gain profit with a fixed number of employees at a specific time. A labor costing system allows the business to achieve its maximum capacity for profitability with a maximum number of employees to pay. It also helps the managers to know how much labor and hours worked are needed for a weekly task or the number working hours of the employee are needed. Using the budget plan of labour costing can help in making more working hours even at the busier times of the year to give the supervisors more hours to assign an extra workforce.

Reaching the maximum efficiency from the employees helps a business owner identify how much revenue can be achieved at the highest level of productivity. This will give the business a big chance for higher total revenue because of the profitable assignment of work where it can be finished faster and at lower production costs accompanied by a productive and efficient workforce.


Labor cost is significant for every business and to control it effectively is critical. Effective control of it means you know where to reduce your expenses without affecting the employees’ benefits and productivity. Reducing the cost of production or services while ensuring the satisfaction of the employee to maintain a good working environment. Labor cost control is a balancing act to create fairness in wage payment and to lessen labor turnover. Learning how to calculate labor costs is very important in how a business or an organization can increase its profit and competitiveness.