How to calculate labour costs: A small business owner’s guide

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Business owners need to deal with a number of major operational costs like rent, inventory costs, labour costs, and a few others, depending on the industry.

This article will focus on the last item in the list, and explore what labour costs really are and how to calculate labour cost. 

Business owners looking to stay on budget and maximize profits must accurately account for labour costs.

Otherwise, it’s easy to overspend or undercharge, and that’s no way to run a business.

However, many small business owners struggle with the challenge of keeping their labour cost low. So, what is involved in this labour cost calculation process exactly? 

What is labour cost, and why do business owners need to calculate it?

Labour cost is the total amount your business spends on employees, including pay for hourly and salaried workers, as well as employee benefits and taxes.

If you are a manufacturing or production-oriented business, then the amount you spend on labour costs also impacts your business’s prime cost like total cost of goods sold plus other costs. This is the metrics that many business owners use to examine their business’s efficiency and margins.

So, it is essential to remember that labour costs are far more than hourly or salaried wages.

But in fact, labour costs include such expenses as payroll taxes, overtime, employer national insurance contributions, bonuses, sick days, maternity and paternity pays, vacation days, insurance, benefits, meals, supplies, training costs and more.

Basically, you can consider anything even remotely related to employee wages as a labour cost. Here’s how to calculate labour cost.

How to calculate labour cost?

Calculating the total cost of labour is a little more complicated than simply adding up the total cost of all the payments. The following is a step-by-step guide to calculating the total labour cost of an employee.

  1. Calculate the gross payment 

For an hourly employee, the gross payment is simply the number of hours worked multiplied by the hourly rate. For a salaried employee, it is simply the salary an employee draws during a given period.

For example, when an employee works full time, they will potentially work 2,080 hours in one year (40 hours x 52 weeks). So you’ll start with this equation:

  • Gross Pay = Pay Rate x Gross hours
  • Gross Pay = £15/hour x 2,080 hours
  • Gross Pay = £31,200
  1. Calculate the additional labour costs

Add together the costs of each payment or benefit like Overtime wages for non-salaried employees, payroll taxes paid by the employer, bonuses, sick pay, vacation days, paid training, employer contributions to retirement accounts, employer-paid health and life insurance.

  1. Calculate the total labour cost

Add together the gross payment and any additional labour costs to find the total labour cost for each employee.

  • Total labour cost = Gross Pay + Additional labour costs

Depending on what you are doing, you may choose to calculate the total labour cost for a year, a week, or the predicted timeframe of a specific project.

The importance of total labour costs

Total labour costs have many implications for small businesses and small business owners.

Correctly calculating total labour costs can help you budget for upcoming projects and appropriately price your products or services.

It can also help you to plan ahead for how many employees you can afford to hire, how many projects you should take on, and which projects are worth your time.

If customers pay your small business on a per-project basis, it is critical to use total labour costs when generating estimates.

If you only include the gross labour costs in your estimate, you will under budget for labour.

When the project is complete, you will need to increase the cost of labour, which may disappoint your customer, or take the additional labour costs out of your profits, which will disappoint you.

Final thought

The dynamics of managing finances in a small business can be intimidating.

Hopefully, this guide on how to calculate labour cost gives you a more straightforward path towards managing the financial future of your small business.

Just keep in mind that calculating labour cost is only helpful to your business if those calculations are accurate.

So, if there is any uncertainty around your labour costs, including how much you’re paying in benefits or taxes, make sure to talk to accountants in Central London for further guidance.