Obviously, it’s a must for your company to learn how to measure direct labor costs. But inaction, what does the direct labor cost formula look like?
Let’s presume you own a marketing agency and for an upcoming client campaign, you’re trying to measure your direct labor costs. You intend to put a graphic designer, a copywriter, and a project planner on the project, and since it’s a big project, you want each team member to devote 50 hours to managing the launch of the campaign in the coming week.
First Step: Define expenses for hours worked
You’re going to have to decide how much money you’re going to pay your staff.
Let ‘s say your graphic designer and copywriter are salaried workers who earn $75,000 a year each, while a non-exempt employee who costs $20 per hour is your coordinator.
Their compensation will be their normal rate of pay for the week since the graphic designer and copywriter are excluded, workers.
Wage rate for graphic designers: $75,000 / 52 weeks = $1,442.311.
Wage rate for copywriters: $75,000 / 52 weeks = $1,442.311
Since the coordinator is a non-exempt worker, you would also have to take into account overtime expenses for any hours worked past 40 hours a week, so 10 hours of overtime (at 1.5 times their daily pay rate) in this situation.
Also, Read: Tax Deductions for Self-Employed
Regular salary costs for the Coordinator: $20 x 40 hours = $800
Overtime salary costs for the Coordinator: $30 x 10 hours = $300
Complete salary expense of the coordinator: $1,100
Second Step: Assess additional costs of labor
It’s time to discuss extra labor costs, including payroll taxes, insurance, and other benefits after you’ve calculated the cost of salaries.
Let ‘s assume you pay your graphic designer and copywriter $600 in payroll taxes each month, your coordinator $350 each month, and each employee $300 in benefits each month which includes health insurance, life insurance, and a retirement contribution.
You will need to break down each of those monthly costs into a weekly cost ,since the project is planned to last a week, to measure the costs for this project:
Copywriter and graphic designer: $900 (payroll taxes and benefits) x 12 months = $10,800 / 52 weeks = $207.69 per week
Coordinator: $650 x 12 months = $7,800 / 52 weeks = $150 per week (payroll taxes and benefits)
Third Step: Direct labor cost estimation
You will measure the direct labor cost for the project until you have both the normal labor costs and extra labor costs for each employee.
Graphic designer: $1,442.31 (regular salary ) + $207.69 (additional labor costs) = $1,650
Copywriter: $1,442.31 (regular salary) + $207.69 (additional labor costs) = $1,650
Coordinator: $1,100 (regular and overtime salaries) + 150 dollars (additional labor costs) = $1,250
The project’s direct labor cost: $1,650 + $1,650 + $1,250 = $4,550
Fourth Step: To guide your decisions, use direct labor costs
You will use those observations to drive your business decisions once you have your direct labor costs.
Let’s assume, for instance, that your client is offering you $10,000 to start a campaign. That would mean that your company would earn $5,500 in profit for a week-long project, and that would also mean that you would want to continue working with that customer on similar projects. But if your customer offered $4,000 for the launch, you would lose $550, which would mean that you would actually not want to tackle a project.
You can also use them once you have your direct labor costs to build budgets for potential projects. For example, if you know you’re going to start a similar campaign every quarter at $10,000 per project, you can use these figures for the rest of the year to make financial estimates. And since all labor costs (not just wages) are taken into account by direct labor costs, those forecasts will be more precise and you will be able to control your annual budget, income, and cash flow better.
Deeper insights into the cost of your labor
As a small business owner, it is important to keep your finger on the pulse of what’s going on with your company financially, and that includes your labor costs. And you have a jumping-off point to calculate your way to deeper insights into your labor expenditures, cash flow, and profits now that you understand how to calculate direct labor costs.
Please bear in mind that estimating direct labor costs is only beneficial to your organization if such figures are correct, so if your labor costs are unclear (including how much you pay in benefits or taxes), make sure you speak to your accountant for more guidance.