When creating estimates, you must take into account the full spectrum of requirements, including the actual cost of employing a staff member aside from the salary the employee earns. If you don’t calculate labor burden your chance of profitability decreases exponentially.
Many companies don’t update their labor burden rate enough. Crunching the numbers to calculate your labor burden will help you effectively quote potential clients and boost your profitability.
What is overhead?
Overhead refers to an expenditure that cannot be easily traced to a job or a division of the firm, unlike labor. Overhead costs do not directly generate revenue but are required to operate the firm. On the income statement, overhead refers to all costs except direct labor, direct materials, and direct expenses.
What is labor burden?
Labor burden is a type of overhead cost. Labor Burden refers to the actual costs above and beyond the employee’s base salary or hourly rate. The burden includes liabilities associated with employee costs. Commonly required labor burden costs include:
- Federal and state payroll taxes (Social Security, Medicare, unemployment)
- Local payroll taxes
- Job training taxes
- Federal or state-mandated workers’ compensation
- Health insurance
Other costs may be included in the labor burden. These vary by firm size, federal and state requirements, and other factors.
- Retirement costs (pension, 401(k), other)
- Flexible spending accounts
- Health savings accounts
- Dental insurance
- Vision care insurance
- Prescription drug programs
- Company vehicle
- Company mobile phone
- Food and beverage offerings
- Wellness activities
- Professional liability insurance
Why is labor burden important?
Profit, plain and simple.
Without knowing the labor burden for each billable employee (really, every employee), profit will be elusive. It is like throwing dart blindfolded after 5 pitchers of brew.
Don’t believe me. Okay . . . How do you determine an employee’s bill rate (and cost rate) with accuracy without knowing all the costs?
1. Benchmark rate
It’s based on hundreds of firms from across the country (maybe the world). Everything is the same for everyone, right? All firms have the same federal and state requirements, the same payroll taxes, the same cost of living . . . Your firm is just a mirror of the rest of the world, nothing is unique or special.
2. Joe’s rate
You’ve been friends with Joe Doe for 20 years. You both started with the same firm out of college. You compete locally with Joe, and yes, your firm has had steady wins against for a long time. Joe also does regional jobs and his firm has grown steadily. Like any good friend, Joe shares information like a labor burden rate.
3. Shoot from the hip
Draw on your experience. The most exceptional managers can follow this path to consistent profit.
So, if employee bill rates are good enough, what is the impact? It all starts with the proposals sent to clients and prospects using the employee bill rates.
Are you charging more than needed – overstated labor burden – to achieve your profit margin? Are you sucking profit margin – understated labor burden?
Bottom Line: Invest at least annually in labor burden calculations.
Calculate labor burden in 7 steps
The 7 steps for determining the labor burden are as follows:
1. Calculate the employee annual gross earning
For a salaried employee, this is the annual base pay before bonuses or other compensation. For an hourly employee, multiply the hourly rate times 2,080 (full time employee).
2. Add up the employer-paid taxes.
Typical taxes include FICA, FUTA, and SUTA. In some states and localities, local taxes and other items may be included in this calculation.
3. Add up the percentage-based costs for the employee.
Common costs include Workers Compensation, liability insurance, and 401K (company contribution portion).
4. Add up the employer-paid benefits.
These costs can be a short or extensive list depending on your firm’s competitive environment and owners’ employee retention plans. Common costs include health insurance, life insurance, meal reimbursement, company car, company mobile phone, and bonuses.
5. Calculate the employee’s annual labor cost
Total 1. through 4. to compute the employee’s annual labor cost.
6. Calculate the actual work hours by the employee.
Actual Work Hours = Annual Paid Hours - Non-Production Hours
Be careful with this calculation. You need to calculate Actual Work Hours. This is NOT the same as paid hours. Actual Work Hours is the time spent by an employee working on a job.
First, add up the Annual Leave Hours.
- Paid Vacation Hours
- Sick Leave Hours
- Company Holidays
Next, add up other types of non-production hours for the employee. For example:
- Training (professional required, firm required, or option for the employee)
- Non-project management activities
- Company strategy and operations meetings
Now, compute the total Non-Production Hours by adding the annual leave hours and the other hours.
Finally, compute the employee’s Actual Work Hours by subtracting the Non-Production Hours from the Annual Paid Hours (typically, 2,080 hours).
7. Calculate the Labor Burden Rate and Multiplier
First, compute the Total Labor Burden Cost per Hour. Divide the employee’s annual labor (5. above) by the actual work hours (6. above).
Next, determine the employer portion of the labor burden cost per hour. Subtract the total labor burden cost per hour from the employee’s hourly pay rate (1. above).
Finally, to compute the Labor Burden Rate (percentage), divide the employer portion of the labor burden cost per hour by the employee’s hourly pay rate. To convert it to a multiplier, add 1 to the percentage.
Labor burden is a foundation for your firm
As mentioned above, labor burden is part of a firm’s overhead. The additional elements relate to the costs of operating your firm that do not directly generate revenue. Rent, telephone charges, utilities, office supplies, maintenance, business insurance, and similar items are common overhead examples. Without them, your firm would likely not exist. You would not have the foundation for delivering your professional services. Overhead is a burden on the overall firm.
Want more tips to increase efficiency and improve your bottom line? Click below to download a free eBook on key financial metrics to measure your project performance.