While it may sound quite insignificant, calculating the Actual Hourly Cost of your employee is one of the most critical functions of a business
Without knowing this cost, it’s impossible for any business to be able to understand their true operating costs, which is an extremely dangerous practice. Determining your Actual Hourly Cost can be a massive headache at times.
In fact, back in 2001, I despised accounting and I didn’t know what Labor Burden was, nor how to generate a Profit & Loss Statement was or a care how to evaluate a Balance Sheet.
Well it turns out that owners and managers today can take full control of their Employee Expenses, without the need to know a single formula or require any spreadsheet experience. I’m going to share this with you today.
Back when I was running my own business as a General Contractor, and despite my cavalier attitude towards accounting, I had built my business to 1 million in sales and 20 Employees. I should have been reeling in success as I had built my business up from a one-man handyman company into a large residential and commercial remodeling company, however I was mired in debt and nearing bankruptcy. We had grown fast, I was unable (or unwilling) to keep up with the accounting portion of the business. While I understood how to get work, take care of customers and my employees alike, what I was severely lacking was even a basic understanding of my Employee Costs or Employee Labor Burden and how they were affecting my bottom line.
It was at that point, as I was writing payroll checks with those free checks that American Express sends you, that I decided max out my last credit card and hire a very expensive financial consultant.
He promptly poured over all of my books, bills, invoices & payroll for nearly nearly a week. When he was done, he not only gave me a large invoice, but presented me with a single Excel workbook that basically added up all of my Employee costs and determined my Actual Employee Hourly Cost, or Total Labor Burden Cost. To my utter shock, this “Actual Hourly Cost” was more than what I was charging! How could this be?
I quickly cut my costs where I could, lowering my burden rate and hourly cost and immediately raised my billing rates. This saved the business and I vowed never again to ignore the financial part of business. I subsequently invested a great effort to learn all of aspects of business accounting and through a ton of hard work and patience it paid off handsomely. After selling the business in 2005, I decided to commit to helping other business owners and managers avoid so many of the mistakes that I have made with my business by creating software and systems and that solves real-world business issues. I started Excel-4-Business with the sole purpose of creating real solutions for real business.
The most important lesson I had learned, that literally turned around my business, was how important it was to understand the Actual Hourly Cost of each of my Employees which, in reality, was astoundingly more than they were actually paid when benefits, taxes, time off, bonuses, reimbursements, non-productive time and a host of other expenses were considered. This applies any type of a business with employees, and not just for contractors and service companies. Understanding this critical expense on a per-employee, per-hour basis allows you take full control of your employee expenses. Once we have that Actual Hourly Cost, also known as Total Labor Burden, we can then add in our Target Profit Margin to determine a correct hourly rate we should be billing our customers or applying those calculated billing amounts to Estimates for Jobs.
The issue in the past has always been that a complex spreadsheet with lots of formulas was required to figure out what that actual cost was. I have read so much online, tried so many applications, and so I wanted to take what I learned and boil it down into just 7 simple, easily digestible, steps. While a spreadsheet is still a great idea to be able to list, display and filter employees when we have this cost, it’s not necessarily needed to grasp the main concept of just a regular hourly cost.
I have read countless articles on Labor Burden Costs & Rates, Hourly Costs and Burden Allocation it can be so confusing. In this short article I am going to break these costs and terms down without lots of accounting terminology so you can have a true understanding of their impact on your business moving forward.
With so many different opinions and complicated spreadsheets its often hard to understand really what is the true definition. I have read so much as well, and today I’m going to simplify that for you so you can fully understand what this means for you and your company.
The Actual Hourly Cost (also knowns as Employee Labor Burden) is simply the ‘Cost to the Employer above the actual Salary or Hourly Rate. The Total Labor Burden is the Labor Burden + Salary or Hourly Rate. In order to fully understand the costs to our company we want to fully annualize all of the associated costs. This creates an even playing field for all employees and then we can break it down on a per hour basis.
Calculate Your Actual Hourly Cost
Gross Earnings – Lets use an example here for our Sample Employee Fred Fredders. Fred is paid $25.00 per hour, and works 5 days a week at 40 hours a week. Our first step is to annualize the income, so at $25.00 / hr at 8 hours a day and 52 weeks totals $52,000
- Total Employee Earnings ($25.00 * 8 * 5 * 52) = $52,000
- Employer Paid Taxes are also a big expense that must be added in. Outside the US, Taxes vary greatly however within the US, Employers are responsible to pay taxes based on a portion of the Employees Salary. The Tax Burden Breakdown as of 2016 is as follows:
FICA (Medicate / Social Security) 7.65% $3978 FUTA (Federal Unemployment Tax Act) .35% $182 State Unemployment Rate varies from state to state, however in our sample above we will use a rate of 2.90% 2.9% $1508 Total Annual Employer Paid Taxes $5668
- Employer Paid Insurance and Other % Based Costs – Insurance is always a large cost to the Employer and plays a large factor in the overall Hourly Costs. The type of insurances can vary greatly from company to company and state to state, however within the United States, there are a handful of industry standard costs, as well as some other common employee expenses. These percentage-based costs can include Workers Compensation, Liability Insurance, possibly a 401K contribution and other %-based costs. Here is a breakdown of what those costs might be for Fred Fredders:
Workers Compensation Insurances (Rates vary widely on this) 4.5% $2340 Liability Insurance (Often Billed as a % of Labor) 2.0% $1040 401K (Company Contribution Portion) 2.0% $1040 Total Insurance & Other Costs: $4420
- Employer Paid Benefits – This can be a very large burden to the employer as there are all types of benefits companies offer Employees such as Paid Health /Life Insurance, Meal & Fuel Reimbursement, Bonuses, etc. For our purposes we will include a few common Benefits however your own Benefits will definitely differ.
Health/Medical Insurance $3000 Fuel Reimbursement $1800 Meals & Travel Reimbursement $900 Christmas Bonus $1000 Total Insurance & Other Costs: $6700
- Total Your Annual Employee Costs – Now we can take all of the total amounts from above to obtain a Total Annual Employee Cost:
Total Gross Annual Earnings $52,000 Total Annual Employer Paid Taxes $5668 Total Employer Paid Insurance & Other % Based Costs $4420 Total Annual Employer Paid Benefits $6700 Total Annual Employee Cost: $68,788
- Determine Actual Work Hours – The next step is to determine the Actual Work Hours of the Employee. This is an area in which people often get wrong as these are the hours in which the employee is Actually Working, which is often much lower than the paid hours. These are actually Production Hours in which the employee is on the job and producing the goods or services that your company is providing. When calculating your Employee’s Actual Hourly Cost, one very important deduction to this which is often missed is the “Non-Productive Hours”. These are hours when the employee is on the job in which the employee is not actively producing goods or services or time which cannot be billed to the customer. Consider if there are just 15 minutes of non productive time in a given 8 hours shift, this would amount to 59 Hours within a year that are paid but not productive or billed out, so it could be a considerable amount of time and must be accounted for as well. Each company should evaluate their workforce to determine the amount of non-billed time to assign to each employee. To Get the Actual Work Hours we must deduct all of the Paid Hours which are not worked, also known as ‘Leave Hours’. (Non-Paid hours are not affected here as we are only concerned with the company costs for this calculation) We will take standard deductions form the Paid Hours to determine the Total Annual Leave Hours. We will also add in the Non-Productive time with a very modest 15 minutes a day however you may want to modify that according to your own company structure.
Paid Vacation (2 weeks) 80 Paid Sick Leave (8 days) 56 Paid Company Holidays (8 Federal US Holidays/Year) 56 Total Non-Productive Hours (15 min per workday) 59 Total Annual Leave Hours: 251 Total Annual Paid Hours (8 hrs/Day, 5 days/week, 52 weeks/ year): 2080 Total Actual Work Hours (2080 – 251) 1829
- To obtain the Actual Hourly Cost (or Labor Burden Cost) its now just simple math as we know we have a Total Annual Employee Cost of $68,788 and Actual Work Hours of 1829 so we divide the Actual Hours by Actual Cost to get a Total Labor Burden Cost of $37.61 ($68,788 / 1829 = $37.61) . There are a few other terms and calculations we can now display that are commonly used within the Industry:
- Employer “Labor Burden” Cost Per Hour – This would be the additional Cost, above the Hourly Rate in which the company is responsible for. In our sample above, the Employee is paid a $25.00 per Hour wage, while the total cost is $37.61. The Employers Burden would be ($37.61 – $25.00 = $12.61). So the Employer Burden is $12.61
- Labor Burden Rate – This is the rate at which the Employer Burden Cost is applied to the Base Hourly wage to obtain a Labor Burden Rate. So in this case our Burden Rate is ($12.61 / $25.00 = .5044) or 50.4%. So we now know that for every dollar of Employee wages, the Employer must pay 50% more in additional Burden Costs, which is critically important when determining Billing & Charge Rates to the customer, or simply an overall actual cost over time.
Now that we have our Actual Employee Cost calculated on a Per Hour Basis. Two additional and important calculations that we may also want to consider Overhead (which is distributed over all employees based on work actual work hours) and Profit Margin, which is based on Minimum and Ideal Profit Margins you have set for the period. to get an extremely accurate Billing Price. I have written a complete article on how to obtain a correct Profit Margin and Selling Price here, so please have a look. I have created an amazing comprehensive application which will do all of the above, automatically and easily. Head over and download a FREE Trial Version Now. You won’t be disappointed.
If you would like to see what your own Employee Hourly Cost is try our Free Online Hourly Cost Calculator.