Understanding Labor Burden and It’s Effect on The Bottom Line

One fact always amazes me when I work with companies on improving profitability. It doesn’t matter if they are a small builder or sub with three employees or contractors doing fifty-million dollars or more in revenues – MOST do not have a clear understanding of what constitutes Labor Burden, how to calculate it, and what their true labor costs are for their individual employees. Another misconception is that you should only be concerned with employees wearing tools who are building things and working in the field.

Sorry, Folks, but that’s not how this works. It may mean that you may start each day losing money, and I’m not talking about a few dollars here or there. I’m talking about up to or over one dollar; for every dollar you pay to your employees, you might be throwing away another dollar. Since employee compensation and related costs are often the largest and riskiest cash outlays for a business, it is imperative that you understand what your true labor costs are. The good news is that you don’t have to be an accountant or CPA to calculate your basic Labor Burden. It’s easier than you might think, and I guarantee you that you will be amazed at the results if you have never run the numbers.

Stick with me here because even though this may sound complicated, it’s not, and even though it will appear like something you will have to pay your accountant hundreds of dollars to do – it’s really pretty simple and thoroughly explained in the following example of how labor costs ultimately affect the bottom line.

First, we have to agree on some definitions and parameters before we dig into the details. This can be a great learning experience and force you to see where your labor dollars go so you can manage them.

Labor Burden is the cost of your labor force aside from the salaries actually paid to an employee. Simply stated, burden is the benefits, costs, and taxes that a company must, or chooses, to pay on their employees. These can include, but are not limited to, the following:

  • State and Federal Payroll Taxes (FICA, unemployment and Social Security)
  • Vacation/Paid Time Off
  • Employee Benefits such as health, life, disability, profit sharing, bonuses and 401(k) match
  • Worker’s Compensation Insurance
  • General Liability & Auto Insurance
  • Mobile Phones & Field Computers
  • Uniforms or Special Work Clothes (think PPE)
  • Training (CEU’s, Safety Training and Certifications, etc.), Motor Vehicle Equipment Repairs and Maintenance
  • Depreciation
  • Office and Warehouse Costs
    (Depending upon the type of work you perform, the equipment you own, the structure of your corporation, and the accounting methods you use, there may be many additional items you need to consider but, for this exercise, we are going to focus on the basics that nearly every contractor faces.)

Another fact that we sometimes fail to consider is the actual number of hours employees are available to work, understanding that they have vacation, sick time, training days, holidays, etc., that they are paid for but not available for productive work. They are costing you whether they are or are not actually at work so this needs to be considered when calculating the employee true hourly costs.

Let’s go over the following definitions to clarify the rules:

Labor Burden: The costs, above and beyond gross compensation, that you incur in order for an employee to perform the work that you hired them to do.

Labor Burden Cost or Fully-Burdened Cost per Production Hour: (Labor Burden Costs + gross payroll labor cost) ÷ the number of actual work (production) hours.

Labor Burden Rate per Production Hour (%): the additional total labor burden costs expressed as a percent, above and beyond an employee’s regular pay, or said another way, it is calculated as follows: Labor Burden Costs ÷ hourly payroll costs.

After you compute an employee’s full-burdened labor costs and divide it by the number of hours the employee actually works on a project, businesses often find that workers typically cost the company upwards of 50 percent to 150 percent above their gross hourly labor rate. Knowing your true labor costs can make the difference between succeeding or failing in our labor- intensive industry.

Let’s look at a real life example.

You have an employee; let’s call him, “Joe, the plumber, the electrician, the carpenter, the painter, equipment operator, superintendent etc.  It doesn’t matter what kind of business you are– Labor Burden is Labor Burden.

Assumptions for this exercise:

Joe, “The Carpenter,“ has been working for you for five years, he has a 401(k) to which the company contributes approximately three percent a year, the company pays for part of his insurance, he has a company cell phone, he drives his own vehicle, but you reimburse him for gas, you provide two (2) days of offsite training for OSHA training, etc., per year, you provide him hand tools for his trade, you provide PPE (hard hats, safety glasses, gloves, etc.), and your company has a yearly Bar-B-Q for employees and their families, which historically costs about 100 dollars per employee and family.

You pay a yearly bonus of around two percent. Your written Policies & Procedures  (you have these, don’t you?) allow for six (6) paid holidays a year, three (3) personal/sick days and two weeks of vacation after two years of employment.

You pay Joe $16.00 per hour which equates to $33,280 ($16 x 8 hours day x 5 days per week x 52 weeks = $33,280) with no overtime.

But–what does Joe really cost you per hour so you can accurately apply his true cost (burdened cost) to a job? First, you need to determine his True Production Hours. How many hours is Joe actually available to perform work. In order to determine the actual hours he is productive, you have to deduct all the time he is paid for but is not actually on the job. The following chart shows that based on the scenario we have outlined above, Joe actually works 254 hours less than you might think.

Chart A – True Production Hour Calculator
Assumes no overtime
True Hour Calculations Weeks Hours Total Hours Yr  
52 40 2,080 2,080 Total hours available for work per year based on 8 hour days x 5 days week
Days
Vacation 10 8 80 Policy allows for 10 days after 2 years employment
Holidays 6 8 48 Policy recognizes 6 paid holidays
Sick / Personal 3 8 24 Policy allows for 3 sick or personal days off per year
Training / Certifications 2 8 16 Company allows for employee training OSHA, License CEU’s, etc. 2 days per year
Administrative / Planning 260 0.33 86 Assume 20 minutes per day employee doing paperwork, reports, planning etc.
254 (254) Total Hours Employee is Paid but not actually on a job or producing work
1,826 Available Working Hours – 2,080 hours less 254 hours = 1,826 productive hours
45.6 Actual weeks employees is available for work this scenario 1,826 / 40 hour week = 45.6

So, armed with the fact that Joe is actually available to work only 1,826 hours a year, you now can determine what Joe really costs you when he shows up to work every day. The Labor Burden Calculator will give you the answer. Again, in this scenario, you will see that Joe actually costs you $27.05 per hour which is $11.05, or 69.1 percent, more per hour than his $16.00 hourly pay rate.

Chart B – Labor Burden Calculator
Employee Joe the Carpenter
Yearly Salary $33,280 Based on $16 x 2,080 hours (5 days x 8 hours x 52 wks = 2,080  hrs)
Base Hourly Pay Rate $16
Burden Costs
Payroll Taxes $780 FICA, FUTA, SUTA
Workman’s Compensation $1,974 Workman’s Compensation
Yearly Health Insurance $5,220 $435 Month Company Contribution
401K Plan Contribution $1,000 Estimated 401k Company Contribution
Cell Phone Costs $840 Based on $70 month average
Gasoline & Maint. Reimbursement $4,800 Based on $400 month average
Training $200 OSHA Courses or Other Training & Certifications
Tools and Equipment $1,200 $100 Month Allowance
PPE / Uniform Allowance $600 $50 Month Allowance
Yearly Entertainment BBQ $100
Total Burden Cost of Employee $16,714
Total Annual Burdened Cost $49,994 Total Annual Burdened Cost = $33,280 (Base Pay)  + $16,714 (Total Burden Costs) = $49,994
Actual Total Annual Working Hours 1,826 See “True Production Hour Calculator” Chart “A”
Production Rate / Hour $27.38 Total Annual Burdened Cost ($49,994) / Total Annual Working Hours (1,826)
Burden Rate Per Hour $11.38 Production Rate ($27.38) / Hour – minus Base Hourly Pay Rate ($16.00)
Labor Burden Rate 71.1% Burden Rate Per Hour ($11.38) / Base Hourly Pay Rate ($16.00)

NOTE: This example if very basic and does not take into many additional items that may be recognized as Labor Burden depending upon your company Policies & Procedures, accounting principles, your deliverable work product and the type of contracts you sign.

Understanding and acknowledging your true labor costs is the difference between failing, just surviving, or making real money.  In this simple example, you can see that Joe actually costs you $49,994, which is $16,714, or 71.1 percent, above and beyond his gross pay of $16.00 per hour, or $33,280 a year.

Multiply this across all your employees, including those in the office, and it is not uncommon to see companies losing tens of thousands of dollars a year due to the fact that they do not understand this basic job cost/accounting principle.

Call us today and start growing your business.

Kent Leighton       kent@flatrockgroup.com       830-201-0678

 WWW.FLATROCKGROUP.COM

© 2014 The FlatRock Group

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About the author

Kent Leighton, Founder of The Flat Rock Group, has more than 40 years of experience in the Construction and Development Industry. Having owned a successful midsize General Contracting firm he understands the opportunities and trials of running a successful business enterprise. His passion is sharing his victories and his scars with leaders and managers to help them grow and prosper.