When it comes down to expenses for businesses, labor costs are a vital aspect that can inarguably not be ignored. As such, it is imperative to have a thorough understanding of these expenses. This piece will introduce you to the wide range of aspects related to labor costs and help ensure you make the best decisions for your business.
What is meant by Labor Costs?
Labor costs refer to the amount of all the wages paid by the company to employees along with the benefits offered and payroll taxes charged by the employer. These costs are majorly divided into two categories - direct costs and indirect costs.
- Direct Costs: Wages of employees who are making the product; includes assembly line workers.
- Indirect Costs: Expenses related to support labor like the employees taking care of the production equipment.
Understanding Cost of Labor
When setting the selling price for a product, the company must take the labor, inventory and overhead expenses into account. All expenses incurred for a product must be considered when calculating the selling price for the product. If any costs incurred are missed out when calculating the selling price, it shall basically reduce the business profits.
The company must adjust the labor costs when the demand for a product rises or falls to ensure they continue to make profits. To do so, a company can reduce the number of workers, reduce inventory, enable higher levels of productivity, or reduce certain elements of production costs.
Direct and Indirect Cost of Labor
If a glass manufacturing company is calculating the selling price for its glass windows, the direct labor costs shall be the expenses which can be directly related to the actual manufacturing process of the product. The company pays workers to operate the equipment that cuts the glass into specific parts to assemble the door and these costs are direct costs.
The company has several employees who are responsible for the security of its factory and warehouses. The expenses incurred to manage such aspects fall under ‘indirect costs’ as they cannot be categorized with a specific production action.
Fixed and Variable Cost of Labor
Labor costs are also categorized as fixed or variable costs. For example, the cost of labor to operate equipment is a variable cost that varies with the level of production of the business. By increasing or decreasing production, a company can easily increase or decrease variable labor costs.
Fixed costs may include fixed labor costs for long-term service contracts. The business may have a contract to perform equipment repair and maintenance with an outside supplier, so this is a fixed cost.
Definition of ‘Wages’ under Different Acts
Definition under the Minimum Wages Act, 1948
As per Section 2(h) of the Minimum Wages Act, 1948, ‘wages’ means any remuneration expressed in money which, in compliance with the express or implied terms of a contract of employment, would be paid to a person employed in connection with their employment or work done in such employment and includes residential rent. This, however, shall not include:
- The value of any house accommodation with light medical care or any other facilities or services that is prohibited by any general or special order of the Government.
- Contributions made by the employer to a personal fund or pension fund or any social insurance.
- Travel allowances or the value of travel allowances.
- The amount paid to the employee to cover special expenses arising from the nature of their work.
- Any gratuity that needs to be paid on discharge.
Definition under the Minimum Wages Act, 1936
Under this Act, wages comprise of all remunerations that is monetary in nature or can be expressed similarly. This can be in the way of salary allowances or otherwise as well. Employees receive such remuneration on fulfilling their terms of employment as expressed or implied in the employment contract.
Definition under the Payment of Gratuity Act, 1972
‘Wages’ means the total remuneration earned by an employee during employment or leave according to their terms or paid to them in case together with remuneration, but excluding bonuses, commissions, house rent, overtime pay, and other benefits.
What to Consider when Calculating Labor Cost?
Labor costs can vary by industry. However, when calculating such costs, following aspects must be taken into consideration:
- Wages
- Payroll Taxes
- Overtime
- Bonuses
- Healthcare
- Days for Illness
- Holidays
- Insurance
- Meal
- Supplies
- Training
- Public Transport
How is Labor Cost Calculated?
• Calculate the gross wages (Gross wage = Annual Working Hours x Gross Hourly Wage)
• Determine actual working hours (Actual Working Hours = Annual Working Hours – Hours not worked)
• Take all other expenses into account. (At this stage, you must add up all other expenses to determine the total cost of our work)
• Finally, calculate total annual labor cost (Total Annual Labor Cost = Gross Wage + Other Annual Costs)
| Note: You must include absences in calculations as employees may be eligible for some paid and sick leaves. Therefore, you must take into account the potential number of leaves by using the industry average. |
How to Lower Labor Costs Effectively?
Considering labor costs are also an expense for your business, you must come up with different ways to reduce it effectively. Here are some tips to help you reduce the labor costs:
Overtime can quickly contribute to increase your labor costs, as you will be paying more to employees who have worked extra hours. This usually takes place due to workload during certain periods of the day, where you might require some extra hands to help manage the work at hand. As such, you must carefully analyze and plan for the busy hours at work and hire more people on a temporary or part-time basis, if necessary, to help manage the same.
You must invest your time in reviewing the processes of your business, spotting out the inefficiencies and taking necessary steps to improve any ineffective aspect you find. It can be quite costly to run a business on an ineffective process, considering it is eventually going to reflect on productivity and, thus, on labor costs. Using the latest technology and automation are just two of the many viable solutions you can use to streamline your business’ processes.
The company has to bear a lot of costs when investing in recruiting new employees and training them. In addition, you also impart certain skills to new employees, which not only takes time but can be considered an investment in improving the employee’s efficiency. As such, leveraging employee retention strategies and creating a better environment that fosters growth shall allow you to retain valuable employees.
Conclusion
Businesses must take labor costs into consideration when calculating their annual expenses and planning any strategies. As such, gaining a deep understanding about labor costs and other business expenses shall prove to be highly beneficial for the business. Furthermore, managing labor costs shall not only help reduce such expenses but increase the overall profits of your organization as well.
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