If you hear the term “Labor Burden” and you want to glaze over a bit, don’t
Labor burden is a crucial concept in running a profitable company. It helps managers understand the true costs and resulting profitability of people, projects and departments. It helps to determine how you should be pricing your labor, and when to hire more when needed.
For the moment, let’s forget about equipment and materials, and propose that all of us are in the business of only selling and providing labor. General labor, expert labor, extraordinary labor, installation labor, engineering labor, commissioning labor, service labor, etc. “Burden” then is the heavy weight of company cost that each labor hour must cover in order for the business to earn a profit.
There are five basic elements to understand for this analysis
These concepts should not be hard to grasp or communicate, but they are important for the business to capture and monitor, and essential to mature management.
1. Direct Labor Cost
Direct Labor Cost is easy. It is the hourly amount you pay an individual to perform tasks toward the completion of identified projects.
2. Burdened Direct Labor Cost
Burdened Direct Labor Cost adds all additional costs required to employ the individual – such as Payroll Taxes, vacation and sick days, health care paid by the company, matching 401K costs, training and development (course costs plus training time away from work), other non-billable time, and any other expenses paid on behalf of the company (like maybe a computer or cell phone). In other words, employing this person carries a burden above and beyond his basic compensation.
3. Indirect Labor Costs
Indirect Labor Costs include all labor costs associated with producing the customer outcome that cannot be directly charged to a project. These might include some project management, administration, procurement, and pre-sales engineering.
4. Overhead Costs
Overhead Costs are those required for the business to exist. Facilities, insurance, utilities, IT infrastructure, software, etc. The Cost of Selling (salaries, commissions for example) is a special category that falls into Overhead Costs (sometimes broken out as General, Administrative and Selling).
5. Fully Burdened Direct Labor Cost
Fully Burdened Direct Labor Cost captures all general overhead and indirect costs that can’t be attributed to the individual or project. These are added together and then divided by the total number of total chargeable direct labor hours. This cost per hour now includes all the company’s costs for running the business (with the exception of equipment and material costs attributed to projects).
Each chargeable employee has his or her individual Fully Burdened Direct Labor Cost.
What does analyzing your company in this way allow you to do?
- Price your labor hours for profitability.
- Accurately determine your “real” gross profit on projects.
- Estimate, schedule and utilize your labor resources more accurately and efficiently.
- Understand your company’s real profit engine.
- Determine how efficient your company is per Chargeable Direct Labor hour.
Knowing the Fully-burdened Direct Labor Cost attributed to the labor hours of the company can actually “lighten the burden” of management decisions when it comes to controlling costs. It allows managers to adjust the ratios of Direct, Indirect and Overhead costs and highlights many management decisions to improve utilization, chargeability and profitability.
So, understanding labor burden shouldn’t put you to sleep. It’s simply an important often overlooked metric that needs to be calculated on an at least an annual basis.
If you haven’t done it recently, now would be a good time.
This article come from our partners at Navigate Management Consulting
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Project-Based Financial Concepts
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