How to Calculate and Recover Your Labor Burden

Posted on September 8, 2020 in Blog ,Improve Financial Management ,Increase Project Profitability ,Solutions360 by

Welcome back to The Brads Show, and our series of discussions about how to build the principles of maturity into your integration business.

labor burden and net profitsIn today’s video, Brad Dempsey and Brad Malone discuss the importance of accurately measuring labor burden, and the impacts to profits.

What is job costing?

A job, or a project is a unit of work. So there is a start and end date. Hopefully, there is a scope of work, there is a budget, possibly a bill of materials, and as we talked about in the previous episodes, hopefully, there is a plan on how to accomplish the job.

Job costing is simply the application of financial measurements to a unit of work. It is like a miniature profit and loss statement just for that project. It has revenue, it has expenses, and hopefully it has profit.

Why is job costing important for integrators?

There are two primary reasons why integrators should do job costing. One of the reasons is tax audit compliance issues. But the more important reason, is about being able to manage your business effectively, to be able to have repeatable projects, have profitable projects, and have them contribute to the bottom line of the business. You need to have some method of accurately measuring what really happens within projects.

What is labor burden?

Labor burden is all those costs that are associated in supporting an employee. That includes things like PTO, holiday, sick days, payroll taxes, benefits, and the utilization, how much of an employee’s time is being spent on actual billable customer work.

If I am an owner of an integration business, I really want to understand the truth about how jobs are being quoted, how they are being executed, and how profitable they really are. We want to work with reality and understand that true cost of labor when we are building our proposals and when we are executing our projects to help manage our business.

When you look at labor burden, I find a lot of companies just pick a number and say, “That should be good enough because I pay my guys $20 an hour. I’ll do cost of goods to $30 an hour and that should be fine.” What are problems when I’m not burdening my labor correctly?

We often hear the term ‘recover my labor burden’. What happens when you do not recover your labor burden?

By recovering your burden, what you’re doing is allocating all of those costs that go towards supporting employees on your income statement. Then you are taking those costs and offsetting them, usually in a contra-account, against your job costing for labor.

Ideally, those two will balance out, so you know that all those extra costs are being allocated correctly into your projects. If you are not doing this measurement on a regular basis, you are probably not getting true, accurate burden rates for your integration projects.

How does calculating accurate labor burden impact gross profit and net profit?

When labor burden rates are not calculated accurately, frequently gross profit is inflated. When commission plans are based on gross profits, this means commissions are also inflated. One of the biggest reasons Solutions360 sees for resistance to having more accurate burden rates is because it often affects commission plans.

First, integrators need to understand the balance between what they are paying commission on, and adjusting rates, versus adjusting margins and giving a false idea of how profitable projects really are.

Second, is accurately measuring your fixed overhead. Your gross profit must cover your overhead and then whatever’s leftover becomes your net profit.

“It comes down to net profit – that is the most important number.” Brad Dempsey, Solutions360 CEO

This information does not necessarily have to be reported to any compliance body. These numbers exist so that we can do a better job of understanding our businesses and be more effective.

Listen to the podcast for the full discussion:

 

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