➗ How Labor Costs Are Calculated: Your Simple Guide - Hourly, Inc. (2023)

Whether you run a restaurant, construction company, or other small business with employees, labor costs are among the biggest expenses you have to cover.

Therefore, it is important to understand what labor costs are and how they are determined. Labor costs don't just mean thatHourly rate you pay an employee. It spans a number ofother expensesthat you need to consider. Only after taking them into account do you get the actual labor costs for your company.

How is the labor cost calculated then? Read on to get a clear overview and make the right calculations for your business.

What are labor costs?

The expenses you pay for each employee reflect your labor costs for that particular employee.

labor costs includedemployee's gross salary, and additional payments on their behalf, such as Social Security and Medicare taxes, and benefits.

You need to keep track of your labor costs and constantly compare them to your earningsPersonnel costs do not hurt your bottom line. This is known as the labor cost percentage and is the key to sound business management and growth.

How are labor costs calculated?

To calculate an employee's labor cost per hour, you need to go through a simple process that takes into account all expenses related to his employment.

The simple formula for hourly labor costs is as follows:

Labor cost per hour = (gross wages + all annual costs) / actual hours worked per year

Let's break each of these calculations into steps.

We'll use a hypothetical employee, Maria, as an example. She is an hourlyTariff employee who works full-time in a companyin California with more than 26 employees. She gets minimum wage of $13.

So how do you calculate Maria's labor costs?

#1. Calculate the gross wage

The first thing you want to find out is an employee's gross salary.

Here is the formula:

Gross pay = gross hourly rate x number of hours worked for a pay period

In this case, let's calculate Maria's gross salary per year. The total hours Maria is expected to work over the period of a year are:

Total hours per year = 40 hours per week x 52 weeks = 2080 hours

This means that her gross salary per year is:

$27,040 = $13 x 2080 hours

#2. Determine the actual working hours

The total working time per year is 2080. However, every employee has to take time off.

Let's assume that Maria has not worked for 12 days this year. To calculate the hours not worked:

Hours not worked = 12 days x 8 hours = 96 hours

Then you can easily calculate the net working hours:

Actual hours worked = total hours per year - hours not worked

In this case that would mean:

1984 hours = 2080 hours - 96 hours

The actual hours Maria worked in a year is 1984 hours.

#3. Determine all annual costs per employee

Next, you need to consider any related expenses you owe for Maria, like taxes and healthcare costs. They are added to their gross salary. Only after you calculate them can you determine the actual labor cost per hour for a specific employee or the actual cost per hour.

Some typical labor costs in addition to actual wages for the worker are:

Income tax:

  • FICA taxes (7.65%) of which 6.2% Social Security and 1.45% Medicare
  • FUTA taxes (standard rate of 6%, but exceptions apply)
  • State Unemployment Tax
  • Local unemployment taxes

Employee bonus:

  • Health insurance
  • Additional insurances such as dental, life or disability
  • retirement provision
  • Paid vacation(sick days and vacation days)
  • meals at work
  • education and training

Other possible outputs:

  • overtime pay
  • work compensation insurance
  • working material

In the case of Maria, here is the breakdown of the additional labor costs:

  • $2,348.56 annual taxes: 6.2% Social Security $1,676.48, 1.45% Medicare $392.08, 0.6% FUTA on first $7,000 $42, and California Unemployment Insurance 3.4% on first 7,000 $, which equals $238
  • $3,120 health insurance
  • $1,200 benefits
  • $500 overtime
  • $500 Meals

So the additional annual cost you have to pay to have Maria on your team is $7,668.56. Of course, this is just an example and these costs can vary widely.

#4. Calculate the total annual wage costs

You can now determine Maria's actual annual labor costs or her total labor costs. That's how it's done:

Annual wage costs = gross salary + other annual costs

In this example the amount is:

34.708,56 $ = 27.040 $ + 7.668,56 $

This is the total cost of Maria's work to your business per year.

#5. Calculate the labor cost per hour

Finally you can calculate Maria's labor cost per hour.

Your hourly rate (wage) is $13. However, you want to get the total cost per hour. Here's how you can do that:

Hourly labor cost = annual labor cost / hours actually worked

For Maria, our hourly wage calculator comes up with the following:

$17.50 per hour = $34,708.56 / 1984 hours

Now you know the actual labor cost per hour for hiring Maria.

Determine your labor cost percentage

Knowing your labor cost expenses per employee is necessary to determine yourslabor cost percentage, which shows you the ratio between your total sales for a given period and your labor costs in that period.

The formula is:

Labor cost share = labor cost of all employees / total sales

Finding your labor cost percentage will help you analyze your personnel expenses more accurately. Here's how to figure out if you need to reduce them to increase yoursoverall profit margins.

The average labor cost percentage should typically be in the range of 20% to 35% of a company's gross sales. However, there are differences depending on the subject area. It's not uncommon for restaurants and other service businesses to have a labor cost share of up to 50%. In other fields, such as heavy industry, the percentage should not be more than 30% to ensure profitability.

Tips to reduce your labor costs

Keeping your labor costs under control is a big part of spending management for your business. This does not mean cutting employee wages and saving on non-wage labor costs. However, it requires observation and attitudeclear attendance rules, over timeAndRegistration of hours worked.

Get the right time tracking

One of the most important tips for reducing your labor costs is thisAccurately track employee hours. Time tracking errors can have serious and costly consequences for your business.

With solutions like Hourly, you can rest assured that your employees will clock in and clock out seamlessly, and that you get the most accurate information about their actual working hours. The platform offers geofencing, which is great for teams on the go because you can designate the physical area where employees can track time.

Keep an eye on overtime

There's not much you can do to reduce most incremental labor costs, like payroll taxes and benefits.

However, you are in control of your team's scheduling. This is how you can regulate the overtime of your employees. There are, of course, situations when you cannot avoid overtime, but try to keep it to a minimum if you want to reduce labor costs.

Keep an eye on labor costs for your business

Keeping track of labor cost calculations and monitoring labor costs is essential to running a successful business, no matter what industry you are in.

When you're ready to take your internal operations to the next level, Hourly can help. Our platform brings together the top features you need in your day-to-day business management. Out oftime trackingAndPayrollToworker compand meetPayroll requirements, we have your back.

wanna get started Just downloadHourly appon your mobile device.


How do you calculate cost per labor hour? ›

How to calculate labor cost per hour. Calculate an employee's labor cost per hour by adding their gross wages to the total cost of related expenses (including annual payroll taxes and annual overhead), then dividing by the number of hours the employee works each year.

How do you calculate labor costs for a small business? ›

Reliable Labor Cost Formula
  1. Total all of the expenses in each category for the year.
  2. Divide that sum by the number of employees you have to get the cost per employee.
  3. Break the cost down per hour by dividing the cost per employee by the number of hours worked per year.
Jul 13, 2021

What is a labor cost example? ›

Examples of direct labor costs include: The hourly salary of a quality assurance inspector is adjusted to include health care benefits and short-term disability. The annual salary of a welder who works on the production line of a steel parts manufacturing company.

How much should I charge per hour? ›

Calculate Your Hourly Rate

Business schools teach a standard formula for determining an hourly rate: Add up your labor and overhead costs, add the profit you want to earn, then divide the total by your hours worked. This is the minimum you must charge to pay your expenses, pay yourself a salary, and earn a profit.

What is Labour cost per hour? ›

Labor cost per hour = (gross pay + all annual costs) / actual worked hours per year. Let's break down each of these calculations into steps.

What is a reasonable labor cost? ›

What is An Acceptable Labor Cost Percentage? An acceptable average cost percentage is 25-35% of gross sales. This can vary greatly depending on the business, industry, and location.

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