Labor cost

What is labor cost?

Labor cost is the encompassing term for all the wages that a company pays to an employee, which includes payroll taxes, benefits, and insurance. 

There are two main categories of labor costs. Wages given to employees who produce goods or services are referred to as direct labor costs. Indirect labor costs, on the other hand, are expenses incurred to maintain production equipment.

How to calculate labor cost

It is important to determine the labor cost as it can also affect the cost of your production and product pricing. Here’s the formula to calculate the labor cost per hour:

Cost of labor = (gross wages + total annual costs) / number of hours worked

Classifications of labor cost

Labor cost can be classified into the following:

Direct labor cost

Direct labor costs are associated with items that are required to manufacture a specific product. As mentioned, direct labor consists of workers who are directly involved in the production or manufacturing of products. 

Direct labor cost also includes the expenses associated with each consumer good or service produced by a corporation. It is often regulated through unique time clock codes that may be assigned to various production divisions to determine a portion of the cost of products sold.

Indirect labor cost

Indirect labor refers to costs that cannot be connected directly to a specific product or service in the company. This relates to employees who render additional services to the company’s entire manufacturing process. 

It is important for business owners to pay for indirect labor with gross income from product sales.

Variable labor cost

Variable labor costs vary according to the overall quantity of output. It changes in response to changes in demand for small and medium enterprises. While most individuals in variable labor are employed directly, some businesses use part-time workers.

Small enterprises typically utilize variable labor employees to reduce labor expenses and ensure that wages do not exceed the revenue of the business.

Fixed labor cost

Fixed labor costs are those that are unlikely to change over an extended period like fixed compensation for business owners and employees.

Fixed labor costs avoid paying management and supervisory employees overtime. Lowering fixed labor costs, on the other hand, is practically difficult without affecting the efficiency of commercial operations.