How to Calculate Labor Costs: The Small Business Owner’s Guide

How to Calculate Labor Costs: The Small Business Owner’s Guide

Deskera Content Team
Deskera Content Team
Table of Contents
Table of Contents

Did you know many small businesses were shut down in 2021 because they were unable to keep the labor cost low?

Depending on the industry, business owners must deal with a variety of significant operational costs such as rent, inventory, labor cost calculations, and a few others.

Labor cost calculations must be appropriately accounted for by business owners who want to stay on budget and optimize earnings.

Otherwise, it's all too simple to overspend or undercharge, which isn't a good way to operate a company part of labor cost calculations.

Let us look more into details in this article:

•What is labor cost, and why is it important for business owners to figure it out?

•Why Calculate Labor Cost?

•How to calculate labour cost?

•The importance of total labor costs

•Employee Labor Percentage: How to Work It Out?

•Labor Percentages for Groups of Workers

•Different Types of Compensation

•As a small business, how do you pay an employee?

What is labor cost, and why is it important for business owners to figure it out?

The total amount spent on employees by your company includes salary for hourly and salaried workers, as well as employee perks and taxes.

If you run a manufacturing or production-oriented company, the amount you spend on labor costs has an impact on your company's prime cost, which includes the total cost of products sold plus other expenses.

Many business owners use this statistic to evaluate their company's efficiency and profitability of labor cost calculations. As a result, it's critical to keep in mind that labor cost calculations are far higher than hourly or salaried pay.

Payroll taxes, overtime, employer national insurance contributions, bonuses, sick days, maternity and paternity pay, training costs, and more are all included in labor cost calculations.

Anything that has anything to do with employee compensation can be considered a labor cost calculations. In small-business operations, labor cost calculations are a crucial component.

It's normal for a business owner to hire staff to execute specific tasks that are critical to the company's success - especially as the company grows.

For labor cost calculations, there are several types of business labor, and each business labor expense can be ascribed to one of them. Accounting software is used by most managers to compute labor cost calculations.

Variable labor, fixed labor, direct labor, and indirect labor are the four categories of labor cost calculations.

•Variable Labor

Variable labor expenses fluctuate according to the entire amount of production output, as the name implies.Hourly employees are the most popular sort of variable labor for small firms of labor cost calculations.

The variable labor cost calculations move in lockstep with the increase or fall in demand for these businesses.While most organizations hire these personnel directly, some use a temporary employment agency to recruit and hire new variable labor staff of labor cost calculations.

Small organizations frequently utilize variable labor staff to keep labor cost calculations  down and ensure that pay does not exceed projected income.

It's uncommon for business owners to guarantee working hours to these personnel since they desire to preserve the right to reduce hours if sales and production output fall short of labor cost calculations.

•Fixed Labor

According to the Small Business Administration, fixed labor cost calculations  stay constant regardless of a company's production output.Fixed labor cost calculations are apparent examples of owners and employees that earn a fixed compensation regardless of total hours worked.

One advantage of constant labor cost calculations is that owners don't have to pay overtime to managers and supervisors.

Lowering fixed labor cost calculations without sacrificing the efficiency or efficacy of business operations, on the other hand, is usually difficult.

•Direct Labor

Direct expenses are costs associated with a specific cost object, such as raw materials needed in the development of a specific product or software used to ensure the quality of a consumer good or service. Labor and direct materials account for the majority of direct expenditures of labor cost calculations.

Variable and constant labor cost calculations  can be classified as direct or indirect labor costs, according to the Financial Accounting Standards Board, which is the authority on the generally accepted accounting principles.

All employees who are responsible for generating a company's products or services are considered direct labor part of labor cost calculations. Quality control engineers, assembly line employees, production supervisors, and delivery truck drivers are all examples of direct labor.

Direct labor, as opposed to indirect labor, refers to the costs associated with each consumer goods or service produced by a corporation part of labor cost calculations.

To determine a portion of the cost of products sold, direct labor is often managed through the use of precise time clock codes that can be linked to various manufacturing departments.

•Indirect Labor

Indirect labor refers to labor cost calculations  that cannot be linked back to a specific product or service, or that are otherwise labor expenses that are shared across the firm, such as administrative function expenses.

Office managers, accountants, sales team members, maintenance personnel, and administrative assistants are some such examples part of labor cost calculations.

While indirect labor contributes to a firm's indirect manufacturing overhead, it is a sort of labor cost calculations that is not allocated to the company's products or services because it affects the entire company.

Because employees provide auxiliary services to the company's overall manufacturing process, this labor cost, unlike direct labor expenses, cannot be ascribed to a single product or service.

It's crucial to remember that indirect labor must be paid for using gross income from product sales part of labor cost calculations. Within your overall business running costs, labor cost and labor cost percentage are two of the most important variables to monitor of labor cost calculations.

Why? Because labour is one of the most expensive aspects of running a restaurant.

According to Chron, restaurant labor cost calculations account for 30-35 percent of overall income on average in the foodservice industry. Furthermore, the labor cost calculations is rising all the time.

In a 2019 research, over half of restaurant operators cited rising labour costs. As a result, several businesses have had to raise menu pricing or cut personnel.

So, what is the difference between labour cost and labour cost percentage? And how can restaurateurs accurately calculate them? The amount you spend on labour has an impact on your prime cost, which is the metric that many restaurateurs use to assess their restaurant's efficiency.

Labour expenditures must be weighed in with your other continuous expenses, such as rent and food. Because labour is by far the largest expense most firms encounter, knowing how to calculate labor cost calculations is critical if you want to run a profitable organization.

Labor cost calculations vary per industry, although they typically account for roughly 60% of overall expenses in most industries.

Employers paid an average of $37.73 per hour worked by non-government workers in March 2020. That figure rises to $52.45 per hour for federal employees.

There is no way to tell how much each extra employee costs your company unless you have a solid labour cost formula.It's impossible to accurately forecast your existing and future hiring capabilities without this information. If you don't know how much labour costs to produce your goods or services, you won't be able to price them correctly.

While it may appear that calculating labour costs is simple, many organisations take a very narrow approach, only accounting for the cost of employee compensation.

This is included in the labour cost formula, but your total labour cost includes all of the costs associated with hiring, onboarding, training, and retaining personnel. This comprises payroll taxes, benefit packages, and other employee-related costs like space and equipment.

Why Calculate Labor Cost?

You wouldn't sign a lease for new office space without first performing the arithmetic to check if the monthly rent was affordable, right? Similarly, you should not hire a new employee unless you have completed a thorough analysis of whether the benefits of hiring them outweigh the financial cost.

Many businesses run into problems as they grow because they overestimate their personnel demands and underestimate the true labor cost calculations.

In the best-case scenario, this reduces profits, and in the worst-case scenario, it necessitates layoffs.Using a labour cost formula, you can get a specific dollar figure for how much each hour of labour cost calculations.

It's far easier to figure out how many full-time and part-time staff you can afford to hire with this amount in mind than it is to estimate. Knowing your labour expenses allows you to determine the best prices for your products, maximizing your revenues. If you undervalue your labour costs, you'll establish prices that are too low and end up with margins that are insufficient to keep your business afloat.

If you overestimate labour costs, you'll end up with excessively expensive prices and won't be able to compete effectively, you should have marketing skills.

When determining how much to charge, consider labour expenditures as well as the cost of goods supplied.Finally, assessing your labor cost calculations might assist you in identifying revenue leaks that are eroding company profits. Employee mobile phone usage, company vehicle mileage, and hiring costs are just a few examples.

Monitoring expenditure patterns in these areas can also aid in the detection of possible fraud.

How to calculate Labour Cost?

It's a little more complicated to calculate the overall cost of labour than just adding up the entire cost of all the payments. The following is a step-by-step guide to calculate an employee's total labour cost with the formula for direct labor cost.

● Calculate the gross payment

The gross remuneration for an hourly employee is just the number of hours worked multiplied by the hourly rate with the the formula for direct labor cost. It is essentially the salary that an employee receives during a certain period for a salaried employee.

When an employee works full-time, for example, they may work 2,080 hours in a year (40 hours x 52 weeks). As a result, you'll begin with the following equation, the formula for direct labor cost.

Gross Pay = Pay Rate x Gross hours

Gross Pay = £15/hour x 2,080 hours

Gross Pay = £31,200

● Calculate the additional labour costs

Add the costs of each payment or benefit with the the formula for direct labor cost, such as non-salaried employees' overtime pay, employer-paid payroll taxes, bonuses, sick pay, vacation days, paid training, employer contributions to retirement plans, and employer-paid health and life insurance of the formula for direct labor cost.

Calculate the total cost of labour

To calculate the total labour cost for each employee use the formula for direct labor cost, add the gross payment and any additional labour cost calculations.

Gross pay with additional labour costs equals total labour cost calculations. You can compute the overall labour cost calculations for a year, a week, or the projected time frame of a given project, depending on what you're doing.


Before you even recruit your first employee, you start incurring labour cost calculations. After all, maintaining a website, promoting job postings, attending job fairs, and other recruitment efforts all cost money.

Some specialist roles may be more expensive to fill than others, such as entry-level employment. The cost-per-hire is the average cost of attracting a new employee for any position with the formula for direct labor cost.

The total of your internal and external recruiting expenses is used to calculate your recruiting costs with the formula for direct labor cost.

Job board fees, background checks, drug tests, career fairs, the setup and maintenance of your career's website, and fees paid to recruiters are all regular recruitment expenses to include in your calculations with the formula for direct labor cost.


This is the most obvious personnel cost, and it's also the simplest. This is the total cost of all of your employees' salaries or hourly wages with

Make sure you use the same period for all of the other categories described below, regardless of the unit of time you use to assess pay costs.

•Benefits and Health Insurance

Another significant labor-related cost is employee benefits. Benefits accounted for $11.82 of the $37.73 hourly employee cost that we mentioned before. This equates to around 30% with the formula for direct labor cost.

In general, the more employees you have, the lower your per-employee benefits will be with the formula for direct labor cost.

Benefits calculations should include health insurance premiums, employer retirement contributions, retirement program administration costs, paid time off, and extra income such as overtime with the formula for direct labor cost.

•Employment Taxes

Your business pays taxes on every employee it hires. This includes federal income taxes, Social Security and Medicare taxes, as well as unemployment compensation. We don't include federal income taxes because they are deducted from the employee's pay.

Employee wages are also withheld for Social Security and Medicare taxes, but the employer is responsible for paying a matching sum on top of that with the formula for direct labor cost. Use the IRS guidance described here to calculate your percentage of the expense for each of these taxes.


In most cases, new employees are not productive straight away. Rather, you'll have to invest time and money in educating them, which should be considered into your labour expenditures with the the formula for direct labor cost.

According to a survey published by Training magazine, the average cost of training per employee in the United States is $1,075 per employee.

Consider travel, training materials, equipment, software, and other digital programs, and payment for outside aid when calculating your training costs with the the formula for direct labor cost.

You can also include loss of productivity, which is the amount of money you are not making since the employee is not completely productive yet if you want to be more exact.

These numbers may be more readily available in some professions, such as sales, but not in others, such as service-based industries with the formula for direct labor cost.


You're probably aware of overhead expenditures like rent and utilities, and you're probably under the impression that they're separate from labour cost calculations.  In reality, the number of staff you have has a direct impact on your overhead.

Because the more employees you hire, the more desks you'll need, and the more square footage of space you'll need, it's best to include overhead in your labour cost calculations.

The cost of your physical workspace, property taxes, electricity, office supplies, equipment, and upkeep are all elements to consider when calculating your overhead costs with the formula for direct labor cost.

If you supply business vehicles, cell phones, laptops, or other equipment to employees, be sure they're included with the formula for direct labor cost.

•Additional Costs to Consider

In addition to the above-mentioned recurrent expenditures, don't forget to account for variable costs such as seasonal or temporary labour, as well as one-time costs such as Christmas bonuses with the with the formula for direct labor cost.

Consider the cost of contractors, such as freelance graphic designers or consultants, and keep in mind that these costs may decrease as you hire more people.

What Is Job Costing?

The practice of recording expenses and revenue for each particular project is known as job costing, sometimes known as project-based accounting.

Job costing examines each project in-depth, separating labor, material, and overhead expenses. Compared to other costing methodologies, it makes fewer assumptions.

In the construction sector, where costs vary greatly from work to job, job costing is a frequent practice. Manufacturers, creative agencies, law firms, and others use it as well.

Job costing can be a useful tool for small business owners to examine specific jobs and determine if any spending can be lowered on similar projects in the future because it monitors costs in detail for each job.

The Importance of Total Labor Costs

For small enterprises and small business owners, total labor costs have numerous advantages.

•Calculating overall labor expenses correctly might help you budget for prospective projects and price your products or services effectively.

•It can also assist you in determining how many staff you can afford to hire, how many projects you should do, and which ones are worthwhile.

•When preparing estimates for customers who pay your small business on a per-project basis, it's vital to use entire labor costs.

•You will be under budget for labor if you solely consider gross labour costs in your estimate.

•When the project is finished, you'll either have to raise the labour cost, which will disappoint your customer, or deduct the higher labour costs from your profits, which will frustrate you.

Employee Labor Percentage: How to Work It Out?

Employee labor percentage, also known as cost of labor percentage, represents a company's overall payroll expenditure as a percentage of gross sales.

Payroll is a significant expenditure for any company, and in some industries, it is the most significant cost.

Employee labor percentage tracking is especially crucial for small business owners since it is a critical measure they must understand to spot problems and chances to save money on payroll.

Employee Labor Percentage Overview

The employee labor or labor cost percentage relates the amount of money a company spends on payroll to the amount of money it makes.

Payroll covers all labor costs, not just salaries and wages. Payroll taxes, such as the Social Security tax, and benefit allocations should also be included.

The gross sales of a company are referred to as revenue. Use gross sales from your company's income statement to calculate the employee labour % for a year. You can use information from interim sales reports when measuring over a shorter period, such as a month or week.

Labor Percentage Calculation

A company's labour cost percentage is calculated by dividing its total payroll by its gross sales. Payroll is a substantial expenditure for most firms; in certain cases, it may be the most significant cost.

Use gross sales from a yearly income statement to calculate the annual employee labour percentage. You can run sales reports if you're measuring a shorter time, such as a week or month.

Gather Sales Information

The top of a company's yearly income statement contains this information. You can locate gross sales on intermediate reports or compute it by aggregating sales figures from daily or weekly reports to figure out employee labor proportion for different periods.

Find Labor Cost

Add up all of your wage and salary expenses. Bonuses, commissions, and other forms of payment should be included. Remember to factor in payroll taxes and employee perks of labor cost calculations.

Determine the percentage

Multiply the labor cost by the gross sales and multiply by 100. Assume total sales are $500,000 and labor costs are $140,000. Multiply $140,000 by $500,000 to get a total of $140,000. The percentage of labour provided by your employees is 28%.

Labor Percentages for Groups of Workers

Calculating employee labor percentages for specific groups of workers is sometimes useful. Manufacturers, for example, must calculate the cost of production, and analyzing this measure can aid in the analysis and control of labor cost calculations.

The employee labor percentage is calculated in the same way, with the exception that you only add the labor cost calculations for the specific group of employees you're interested in.

The Significance of Labor Cost

The ability to successfully regulate the cost of labor is crucial for a small organization. Labor costs typically range from 20 to 35 percent of gross sales of labor cost calculations.

Employee percentages vary by industry; a service business may have a percentage of 50 percent or higher, whereas a factory must maintain a ratio below 30 percent.

Cutting labor costs, on the other hand, is a delicate balancing act. Payroll cuts that are too drastic can make it difficult to recruit and retain effective staff of labor cost calculations.

Effective labor cost control entails discovering cost-cutting opportunities without jeopardizing employee motivation or productivity.

Tips to Reduce Your Labor Costs

Keeping your labor expenditures under control is an important aspect of your company's expense management. This should not imply lowering staff compensation or cutting shortcuts on additional labor expenditures.

It does, however, necessitate being vigilant and establishing clear guidelines for attendance, overtime, and time reporting.

Get Time Tracking Right

Accurately tracking staff hours is one of the most significant techniques for lowering labor costs. Time tracking errors can have major and costly ramifications for your company.

Keep an Eye on Overtime Hours

Most of the additional labor expenditures, such as payroll taxes and benefits, are beyond your control.

You do, however, have control over your team's schedule. This implies you can control how many overtime hours your workers work.

Of course, there are times when overtime is unavoidable, but if you want to cut labor expenditures, keep it to a minimum.

How to pay the staff?

Learning how to pay your staff may seem difficult if you're a new business owner. You can't just hand them a wad of cash from your bank account, after all. You must keep legal records of every dollar that travels from your hands to theirs.

Different Types of Compensation

There are three main ways in which companies pay their workers:

•Hourly Compensation

Hourly pay is calculated on a per-hour basis. The amount of time an employee works during a pay period determines their salary. You may, for example, pay an associate $20 per hour for their services. They are owed $1,600 if they work 80 hours in a pay period.

A part-time employee or someone who does not have a steady schedule, such as a restaurant server, would benefit from an hourly wage.

Hourly workers are typically considered non-exempt, which means they are eligible for overtime compensation.

If you're still getting your firm up and running and figuring out how many employees you'll need and how often you'll need them, you can decide to pay a new hire an hourly wage.

•Salaried Compensation

Salaried personnel are paid a set amount each payday, which is calculated by dividing their annual wage by the number of pay periods.

With a $60,000 yearly salary and a bi-weekly pay period, for example, an employee will receive $2,307 in pre-tax wages per payday.

Salaries are most appropriate for corporate jobs where the employee's time contribution is predictable. Overtime pay is usually not available to salaried staff.

•Commission-Based Compensation

Employees can also be paid on a commission basis. They may be paid a low base rate, which could be hourly or salaried, with bonus compensation if they met predetermined sales targets.

A full-time salesperson at your organization, for example, might earn a base yearly pay of $35,000. They also get paid a commission depending on a proportion of the agreements they close.

Employees in sales roles benefit from commission-based income since it motivates them to achieve specific objectives.

To verify that you are properly rewarding your employees while complying with minimum wage and overtime requirements, see the FLSA.

How Much to Pay an Employee?

The amount you should pay your employees is determined by how much your competitors pay for similar jobs and the type of business you own.

Conduct market research to find out how much other companies in your area and location pay for the position you're hiring for or the type of labor you require.

As a small business, how do you pay an employee?

Set up payroll to begin paying personnel, and be sure to select a payroll system that makes sense to you.

Decide if you'll pay your staff weekly, biweekly, semimonthly, monthly, or on a different schedule entirely. After that, calculate your employees' gross salary for the pay period as follows:

Multiply the hourly rate by the number of hours worked during the pay period for hourly employees. Remember to remove any unscheduled time from your estimates if they took any unexpected time off.

Employees who are paid on a salary: Multiply their annual salary by the number of pay periods in your annual payroll plan.

Commission employees: Determine whether they are paid on an hourly or salaried basis. Then, based on your company's compensation structure, add their commission earnings for that pay period.

How to Pay an Employee?

•Calculate Net Pay

You've calculated your employees' gross salary and the amount of tax withheld from their paycheck. Subtract the amount deducted from their gross salary to arrive at their net pay.

For example, if an employee's gross compensation for the pay period is $2,500 and $680 in taxes must be withheld, the employee will receive $1,820 on payday.

•Paychecks should be distributed to your employees

It's now time to pay your employees their owed net compensation. The most common methods of paying an employee are checks and direct deposits.

If you use direct deposit, consult the bank details provided by your employees. Alternatively, you can have checks cut for employees by your bank or payroll provider.

•File Taxes

Paying taxes on behalf of your W-2 employees is your responsibility. Take the part of the employee's paycheck that has been withheld and distribute it to the appropriate places for tax filings.

File taxes with the IRS, your state's tax collection agency, and the tax collection agency for your municipality. It's worth noting that some taxes are solely paid by the employer.

•Pay Into Benefits

The government will not receive all of the withheld salaries. A portion of your salary may go toward employee benefits, depending on your firm. Deposit into the appropriate accounts on behalf of your employees if you offer any employee benefits programs.

•Update Payroll Records

In the event of an audit, you'll need to retain your payroll records for several years. Maintain an up-to-date, well-organized, and easily accessible payroll register.Include details on who was paid, how long they worked, how much they were paid, and what taxes were deducted.

Best Payroll Solution for Small Businesses

Payroll appears to be a difficult task, doesn't it? How do small business owners deal with the situation?

Businesses at the enterprise level have in-house teams dedicated to paying personnel. Small firms may not be able to afford a payroll specialist or may not have enough employees to justify the labor cost calculations.

In the majority of cases, however, even one-person enterprises are responsible for labor law compliance and tax withholding.

In a small firm, payroll software is the most efficient way to pay staff. It saves both money and time. Payroll software automates every stage of the detailed payroll process we just went through, including payment distribution.

Paying a 1099 employee is as simple as paying them their gross wages. To put it another way, keep your standard payroll procedures in place but don't withhold their taxes.

1099 workers aren't officially employees. They are referred to as independent contractors.

It is the responsibility of independent contractors to pay their payroll taxes. They'll be responsible for filing all of their state and federal taxes part of labor cost calculations.

If the person paying for the work has control over the ultimate product or outcome but not over how the work is done, the person is classed as an independent contractor.

The contractor, not your company, would handle quarterly tax payments to the IRS and state and local governments. While you can pay independent contractors a set fee, you can't offer them a salary; otherwise, they'd be deemed non-exempt workers, and you'd have to provide them with a W-2.

If you're unsure whether someone is an employee or an independent contractor, you should seek legal advice from a lawyer who can explain how federal labor regulations relate to your business. You must ensure that you are paying your employees by the FLSA to avoid any potential litigation or legal difficulties.

How Deskera Can Assist You?

As a business, you must be diligent with employee leave management. Deskera People allows you to conveniently manage leave, attendance, payroll, and other expenses. Generating payslips for your employees is now easy as the platform also digitizes and automates HR processes.

Try Deskera for your Business
Sign up for Free Trial Today!
Deskera People

Key Takeaways

  • Labor expenditures must be appropriately accounted for by business owners who want to stay on budget and optimize earnings.
  • The total amount spent on employees by your company includes salary for hourly and salaried workers, as well as employee perks and taxes.
  • Variable labor expenses fluctuate according to the entire amount of production output, as the name implies.
  • If you don't know how much labour costs to produce your goods or services, you won't be able to price them correctly.
  • Finally, assessing your labour costs might assist you in identifying revenue leaks that are eroding company profits.
  • It's a little more complicated to calculate the overall cost of labour than just adding up the entire cost of all the payments.
  • For small enterprises and small business owners, total labor costs have numerous advantages.
  • Keeping your labor expenditures under control is an important aspect of your company's expense management.
  • It is the responsibility of independent contractors to pay their payroll taxes. They'll be responsible for filing all of their state and federal taxes
What is Overtime?
Thinking of making your employees work more than 40 hours a week? Think again asit can result in a loss instead of profit! Wondering how? Well, this is becauseof the overtime rules and regulations. Being aware of the overtime basics can ensure that your employees are notgetting underpaid. Rules…
What Organizational Structure Should My Team Use?
Are you looking for new ways to organize and lead your team? You might beshocked to learn that there are a variety of approaches to achieving anorganizational structure that boosts team productivity. The links between activities, leadership, and team members are defined by theteam structure. Wh…
Differences Between a Part-Time and Full-Time Employee
Out of a total 100% full-time employees, 43.6% were women, and 56.4% were men.In contrast, in the case of part-time employees, 63% were women, and 37% weremen. These are the most recent statistics of the US Department of Labor showing thetrends of part-time and full-time employees in the USA in …

Hey! Try Deskera Now!

Everything to Run Your Business

Get Accounting, CRM & Payroll in one integrated package with Deskera All-in-One.

Great! Next, complete checkout for full access to Deskera Blog
Welcome back! You've successfully signed in
You've successfully subscribed to Deskera Blog
Success! Your account is fully activated, you now have access to all content
Success! Your billing info has been updated
Your billing was not updated