Calculating the Actual Hourly Cost of Labor
Labor costs constitute a significant portion of the Direct Costs associated with business operations. When estimating or quoting a price to a customer, knowing the Effective Labor Rate, which is the actual labor cost per utilized hour, is essential for determining the labor costs and time required to complete the project or job. In addition to verifying what a utilized hour truly costs, the Effective Labor Rate also serves as the labor basis of the Man Hour Rate.
When the real cost of Direct Labor is known, company management will be able to better estimate the total Direct Cost of a project or activity, will be able to better estimate or determine the profit potential of a project or activity, will be able to better determine the Break Even points of the project or the business and prices, as well as to better identify areas to improve or to enhance Utilization and Efficiency.
Determining the Effective Labor Rate requires the calculation of Financial Burdens, Utilization, and Efficiency to the base wages. The Financial Burden consists of the additional fees and monetary benefits the company pays on behalf of the employee.
Obviously, any improper, omitted, or incomplete calculation of Financial Labor Costs, or Labor Burden as it is commonly known, will have a significant impact on Operating Income and Profits. Typical Financial Burdens that must be paid by the company include the FICA and Medicare costs that are matched by the company as well as Federal (FUTA) and State (SUTA) Unemployment tax assessments. Portions of healthcare Insurance premiums paid by the company on behalf of the employee, and Workmen's Compensation insurance premium hourly allocation are also typically attached to the Financial Labor Costs or Labor Burden. There are other expenses as well depending on the individual company situation or collective bargaining agreements.
However, identifying and attaching the Financial Burden on Labor Costs is only part of the Effective Labor Rate calculation. The Utilization and Efficiency adjustments that affect the business must also be calculated and determined.
One should not confuse Utilization and Efficiency with Productivity and Performance. Productivity is an assessment of Quantity while Performance is an assessment of Quality.
Utilization is the measurement and comparison of available or eligible working time of an employee compared to the wages paid to the employee. Efficiency is the measurement and comparison of time to complete tasks. For example, a brick mason may be expected to lay eight courses a bricks in a wall in eight hours to be productive. However, if the brick mason performs this task in a quality fashion, but does so in only six hours, it may be a job well done but not an efficient use of time if he performs nothing else in the two hours remaining on his shift.
The Utilization and Efficiency calculations adjust for non-utilized financially compensated time when the employee is not available to work at the job site or when environmental conditions such as extreme heat or cold weather negatively affect work place efficiency.
Adjusting the number of Utilized hours and the Financial Burden unit of compensation will result in the cost of a utilized hour for the employee or the Effective Labor Rate. Adjustments to Utilized hours include all forms of Paid Time Off including holidays, vacations, and paid breaks.
Typically the maximum amount of paid hours is 2080 hours (52 weeks at 40 hours per week). Adjustments to Utilized hours include all forms of Paid Time Off including holidays, vacations, and paid breaks.
Adjusting the number of Utilized hours and the Efficiency Factor to the Financially Burdened unit of compensation will result in the cost of a utilized hour for the employee or the Effective Labor Rate.
The consequence or result of these additional charges will vary by location and base hourly rate, but as an example the cost of an employee earning $17.50 an hour base rate could be $21.00 or more once the Financial Burdens are added.
Effective Overtime Rates are not 1-1/2 or 2 times the Effective Labor Rates. This is a common misunderstanding or miscalculation that must be avoided.
In the analysis of the Effective Labor Rate nearly all of the Financial and Utilization burdens are absorbed in the straight time rate. Consequently, the Effective Overtime Rate is calculated solely on straight time plus the overtime premium, FICA, Medicare, and the Efficiency Rate, so the real cost of an overtime hour is calculated differently. (Consistent with the findings and statistics associated with workplace analysis that show overtime as less efficient due mostly to fatigue, the Efficiency Factor for Overtime hours should be reduced.)
Usually only FICA and Medicare Taxes carry over to Overtime. Calculation of the Effective Overtime Rate for hourly employees of a business is simply the hourly base rate multiplied times the premium rate plus FICA and Medicare costs.
FICA applies to the overtime premium unless the employee has reached the FICA wage cap. Medicare always applies.
It is not unusual for the Effective Overtime Rate to be only slightly higher than the Effective Labor Rate. This is valuable information when the business or operations manager must decide whether completing a project on a specific day is desirable even though Overtime pay will be necessary. Using the $17.50 hourly rate example used previously, the Effective Overtime Rate for 1.5 times the hourly rate may equal $28.25 while the Effective Overtime Rate for 2.0 times the hourly rate may equal $37.68.
In other words, when the job site manager reports to company management on Thursday after lunch that the current project will take only about a half a day on Friday to complete, should company management authorize a few hours of overtime on Thursday to complete the job so that this crew can start a new job on Friday morning?
Well what do you think? Do you tell the crew to go back to the job on Friday and be ready to start a new job on Monday or authorize a few overtime hours?
I say yes to overtime because most likely the half day projected for Friday will actually become a full day.
If you would like templates for calculating both the Effective Labor Rate and the Effective Overtime rates for your business, just send me an email message at dlbrown44@yahoo.com and I will email the docs to you.This is no obligation or fee. Thanks for reading my articles.
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