labor cost business plan

• HR & Payroll

How to Calculate Labor Costs: The Small Business Owner’s Guide

Did you know many small businesses were shut down in 2021 because they were unable to keep the labor cost low?

Depending on the industry, business owners must deal with a variety of significant operational costs such as rent, inventory, labor cost calculations, and a few others.

Labor cost calculations must be appropriately accounted for by business owners who want to stay on budget and optimize earnings.

Otherwise, it's all too simple to overspend or undercharge, which isn't a good way to operate a company part of labor cost calculations.

Let us look more into details in this article:

•What is labor cost, and why is it important for business owners to figure it out?

•Why Calculate Labor Cost?

•How to calculate labour cost?

•The importance of total labor costs

•Employee Labor Percentage: How to Work It Out?

•Labor Percentages for Groups of Workers

•Different Types of Compensation

•As a small business, how do you pay an employee?

What is labor cost, and why is it important for business owners to figure it out?

• The total amount spent on employees by your company includes salary for hourly and salaried workers, as well as employee perks and taxes.

If you run a manufacturing or production-oriented company, the amount you spend on labor costs has an impact on your company's prime cost, which includes the total cost of products sold plus other expenses.

Many business owners use this statistic to evaluate their company's efficiency and profitability of labor cost calculations. As a result, it's critical to keep in mind that labor cost calculations are far higher than hourly or salaried pay.

Payroll taxes, overtime, employer national insurance contributions, bonuses, sick days, maternity and paternity pay, training costs, and more are all included in labor cost calculations.

Anything that has anything to do with employee compensation can be considered a labor cost calculations. In small-business operations, labor cost calculations are a crucial component.

It's normal for a business owner to hire staff to execute specific tasks that are critical to the company's success - especially as the company grows.

For labor cost calculations, there are several types of business labor, and each business labor expense can be ascribed to one of them. Accounting software is used by most managers to compute labor cost calculations.

Variable labor, fixed labor, direct labor, and indirect labor are the four categories of labor cost calculations.

•Variable Labor

Variable labor expenses fluctuate according to the entire amount of production output, as the name implies.Hourly employees are the most popular sort of variable labor for small firms of labor cost calculations.

The variable labor cost calculations move in lockstep with the increase or fall in demand for these businesses.While most organizations hire these personnel directly, some use a temporary employment agency to recruit and hire new variable labor staff of labor cost calculations.

Small organizations frequently utilize variable labor staff to keep labor cost calculations  down and ensure that pay does not exceed projected income.

It's uncommon for business owners to guarantee working hours to these personnel since they desire to preserve the right to reduce hours if sales and production output fall short of labor cost calculations.

•Fixed Labor

According to the Small Business Administration, fixed labor cost calculations  stay constant regardless of a company's production output.Fixed labor cost calculations are apparent examples of owners and employees that earn a fixed compensation regardless of total hours worked.

One advantage of constant labor cost calculations is that owners don't have to pay overtime to managers and supervisors.

Lowering fixed labor cost calculations without sacrificing the efficiency or efficacy of business operations, on the other hand, is usually difficult.

•Direct Labo r

Direct expenses are costs associated with a specific cost object, such as raw materials needed in the development of a specific product or software used to ensure the quality of a consumer good or service. Labor and direct materials account for the majority of direct expenditures of labor cost calculations.

Variable and constant labor cost calculations  can be classified as direct or indirect labor costs, according to the Financial Accounting Standards Board, which is the authority on the generally accepted accounting principles.

All employees who are responsible for generating a company's products or services are considered direct labor part of labor cost calculations. Quality control engineers, assembly line employees, production supervisors, and delivery truck drivers are all examples of direct labor.

Direct labor, as opposed to indirect labor, refers to the costs associated with each consumer goods or service produced by a corporation part of labor cost calculations.

To determine a portion of the cost of products sold, direct labor is often managed through the use of precise time clock codes that can be linked to various manufacturing departments.

•Indirect Labor

Indirect labor refers to labor cost calculations  that cannot be linked back to a specific product or service, or that are otherwise labor expenses that are shared across the firm, such as administrative function expenses.

Office managers, accountants, sales team members, maintenance personnel, and administrative assistants are some such examples part of labor cost calculations.

While indirect labor contributes to a firm's indirect manufacturing overhead, it is a sort of labor cost calculations that is not allocated to the company's products or services because it affects the entire company.

Because employees provide auxiliary services to the company's overall manufacturing process, this labor cost, unlike direct labor expenses, cannot be ascribed to a single product or service.

It's crucial to remember that indirect labor must be paid for using gross income from product sales part of labor cost calculations. Within your overall business running costs, labor cost and labor cost percentage are two of the most important variables to monitor of labor cost calculations.

Why? Because labour is one of the most expensive aspects of running a restaurant.

According to Chron, restaurant labor cost calculations account for 30-35 percent of overall income on average in the foodservice industry. Furthermore, the labor cost calculations is rising all the time.

In a 2019 research, over half of restaurant operators cited rising labour costs. As a result, several businesses have had to raise menu pricing or cut personnel.

So, what is the difference between labour cost and labour cost percentage? And how can restaurateurs accurately calculate them? The amount you spend on labour has an impact on your prime cost, which is the metric that many restaurateurs use to assess their restaurant's efficiency.

Labour expenditures must be weighed in with your other continuous expenses, such as rent and food. Because labour is by far the largest expense most firms encounter, knowing how to calculate labor cost calculations is critical if you want to run a profitable organization.

Labor cost calculations vary per industry, although they typically account for roughly 60% of overall expenses in most industries.

Employers paid an average of $37.73 per hour worked by non-government workers in March 2020. That figure rises to $52.45 per hour for federal employees.

There is no way to tell how much each extra employee costs your company unless you have a solid labour cost formula.It's impossible to accurately forecast your existing and future hiring capabilities without this information. If you don't know how much labour costs to produce your goods or services, you won't be able to price them correctly.

While it may appear that calculating labour costs is simple, many organisations take a very narrow approach, only accounting for the cost of employee compensation.

This is included in the labour cost formula, but your total labour cost includes all of the costs associated with hiring, onboarding, training, and retaining personnel. This comprises payroll taxes, benefit packages, and other employee-related costs like space and equipment.

Why Calculate Labor Cost?

You wouldn't sign a lease for new office space without first performing the arithmetic to check if the monthly rent was affordable, right? Similarly, you should not hire a new employee unless you have completed a thorough analysis of whether the benefits of hiring them outweigh the financial cost.

Many businesses run into problems as they grow because they overestimate their personnel demands and underestimate the true labor cost calculations.

In the best-case scenario, this reduces profits, and in the worst-case scenario, it necessitates layoffs.Using a labour cost formula, you can get a specific dollar figure for how much each hour of labour cost calculations.

It's far easier to figure out how many full-time and part-time staff you can afford to hire with this amount in mind than it is to estimate. Knowing your labour expenses allows you to determine the best prices for your products, maximizing your revenues. If you undervalue your labour costs, you'll establish prices that are too low and end up with margins that are insufficient to keep your business afloat.

If you overestimate labour costs, you'll end up with excessively expensive prices and won't be able to compete effectively, you should have marketing skills.

When determining how much to charge, consider labour expenditures as well as the cost of goods supplied.Finally, assessing your labor cost calculations might assist you in identifying revenue leaks that are eroding company profits. Employee mobile phone usage, company vehicle mileage, and hiring costs are just a few examples.

Monitoring expenditure patterns in these areas can also aid in the detection of possible fraud.

How to calculate Labour Cost?

It's a little more complicated to calculate the overall cost of labour than just adding up the entire cost of all the payments. The following is a step-by-step guide to calculate an employee's total labour cost with the formula for direct labor cost.

● Calculate the gross paymen t

The gross remuneration for an hourly employee is just the number of hours worked multiplied by the hourly rate with the the formula for direct labor cost. It is essentially the salary that an employee receives during a certain period for a salaried employee.

When an employee works full-time, for example, they may work 2,080 hours in a year (40 hours x 52 weeks). As a result, you'll begin with the following equation, the formula for direct labor cost.

Gross Pay = Pay Rate x Gross hours

Gross Pay = £15/hour x 2,080 hours

Gross Pay = £31,200

● Calculate the additional labour costs

Add the costs of each payment or benefit with the the formula for direct labor cost, such as non-salaried employees' overtime pay, employer-paid payroll taxes, bonuses, sick pay, vacation days, paid training, employer contributions to retirement plans, and employer-paid health and life insurance of the formula for direct labor cost.

● Calculate the total cost of labour

To calculate the total labour cost for each employee use the formula for direct labor cost, add the gross payment and any additional labour cost calculations.

Gross pay with additional labour costs equals total labour cost calculations. You can compute the overall labour cost calculations for a year, a week, or the projected time frame of a given project, depending on what you're doing.

• Recruitment

Before you even recruit your first employee, you start incurring labour cost calculations. After all, maintaining a website, promoting job postings, attending job fairs, and other recruitment efforts all cost money.

Some specialist roles may be more expensive to fill than others, such as entry-level employment. The cost-per-hire is the average cost of attracting a new employee for any position with the formula for direct labor cost.

The total of your internal and external recruiting expenses is used to calculate your recruiting costs with the formula for direct labor cost.

Job board fees, background checks, drug tests, career fairs, the setup and maintenance of your career's website, and fees paid to recruiters are all regular recruitment expenses to include in your calculations with the formula for direct labor cost.

This is the most obvious personnel cost, and it's also the simplest. This is the total cost of all of your employees' salaries or hourly wages with

Make sure you use the same period for all of the other categories described below, regardless of the unit of time you use to assess pay costs.

•Benefits and Health Insurance

Another significant labor-related cost is employee benefits. Benefits accounted for $11.82 of the $37.73 hourly employee cost that we mentioned before. This equates to around 30% with the formula for direct labor cost.

In general, the more employees you have, the lower your per-employee benefits will be with the formula for direct labor cost.

Benefits calculations should include health insurance premiums, employer retirement contributions, retirement program administration costs, paid time off, and extra income such as overtime with the formula for direct labor cost.

•Employment Taxes

Your business pays taxes on every employee it hires. This includes federal income taxes, Social Security and Medicare taxes, as well as unemployment compensation. We don't include federal income taxes because they are deducted from the employee's pay.

Employee wages are also withheld for Social Security and Medicare taxes, but the employer is responsible for paying a matching sum on top of that with the formula for direct labor cost. Use the IRS guidance described here to calculate your percentage of the expense for each of these taxes.

In most cases, new employees are not productive straight away. Rather, you'll have to invest time and money in educating them, which should be considered into your labour expenditures with the the formula for direct labor cost.

According to a survey published by Training magazine, the average cost of training per employee in the United States is $1,075 per employee.

Consider travel, training materials, equipment, software, and other digital programs, and payment for outside aid when calculating your training costs with the the formula for direct labor cost.

You can also include loss of productivity, which is the amount of money you are not making since the employee is not completely productive yet if you want to be more exact.

These numbers may be more readily available in some professions, such as sales, but not in others, such as service-based industries with the formula for direct labor cost.

You're probably aware of overhead expenditures like rent and utilities, and you're probably under the impression that they're separate from labour cost calculations.  In reality, the number of staff you have has a direct impact on your overhead.

Because the more employees you hire, the more desks you'll need, and the more square footage of space you'll need, it's best to include overhead in your labour cost calculations.

The cost of your physical workspace, property taxes, electricity, office supplies, equipment, and upkeep are all elements to consider when calculating your overhead costs with the formula for direct labor cost.

If you supply business vehicles, cell phones, laptops, or other equipment to employees, be sure they're included with the formula for direct labor cost.

•Additional Costs to Consider

In addition to the above-mentioned recurrent expenditures, don't forget to account for variable costs such as seasonal or temporary labour, as well as one-time costs such as Christmas bonuses with the with the formula for direct labor cost.

Consider the cost of contractors, such as freelance graphic designers or consultants, and keep in mind that these costs may decrease as you hire more people.

What Is Job Costing?

The practice of recording expenses and revenue for each particular project is known as job costing, sometimes known as project-based accounting.

Job costing examines each project in-depth, separating labor, material, and overhead expenses. Compared to other costing methodologies, it makes fewer assumptions.

In the construction sector, where costs vary greatly from work to job, job costing is a frequent practice. Manufacturers, creative agencies, law firms, and others use it as well.

Job costing can be a useful tool for small business owners to examine specific jobs and determine if any spending can be lowered on similar projects in the future because it monitors costs in detail for each job.

The Importance of Total Labor Costs

• For small enterprises and small business owners, total labor costs have numerous advantages.

•Calculating overall labor expenses correctly might help you budget for prospective projects and price your products or services effectively.

•It can also assist you in determining how many staff you can afford to hire, how many projects you should do, and which ones are worthwhile.

•When preparing estimates for customers who pay your small business on a per-project basis, it's vital to use entire labor costs.

•You will be under budget for labor if you solely consider gross labour costs in your estimate.

•When the project is finished, you'll either have to raise the labour cost, which will disappoint your customer, or deduct the higher labour costs from your profits, which will frustrate you.

Employee Labor Percentage: How to Work It Out?

Employee labor percentage, also known as cost of labor percentage, represents a company's overall payroll expenditure as a percentage of gross sales.

Payroll is a significant expenditure for any company, and in some industries, it is the most significant cost.

Employee labor percentage tracking is especially crucial for small business owners since it is a critical measure they must understand to spot problems and chances to save money on payroll.

Employee Labor Percentage Overview

The employee labor or labor cost percentage relates the amount of money a company spends on payroll to the amount of money it makes.

Payroll covers all labor costs, not just salaries and wages. Payroll taxes, such as the Social Security tax, and benefit allocations should also be included.

The gross sales of a company are referred to as revenue. Use gross sales from your company's income statement to calculate the employee labour % for a year. You can use information from interim sales reports when measuring over a shorter period, such as a month or week.

Labor Percentage Calculation

A company's labour cost percentage is calculated by dividing its total payroll by its gross sales. Payroll is a substantial expenditure for most firms; in certain cases, it may be the most significant cost.

Use gross sales from a yearly income statement to calculate the annual employee labour percentage. You can run sales reports if you're measuring a shorter time, such as a week or month.

Gather Sales Information

The top of a company's yearly income statement contains this information. You can locate gross sales on intermediate reports or compute it by aggregating sales figures from daily or weekly reports to figure out employee labor proportion for different periods.

Find Labor Cost

Add up all of your wage and salary expenses. Bonuses, commissions, and other forms of payment should be included. Remember to factor in payroll taxes and employee perks of labor cost calculations.

Determine the percentage

Multiply the labor cost by the gross sales and multiply by 100. Assume total sales are $500,000 and labor costs are $140,000. Multiply $140,000 by $500,000 to get a total of $140,000. The percentage of labour provided by your employees is 28%.

Labor Percentages for Groups of Workers

Calculating employee labor percentages for specific groups of workers is sometimes useful. Manufacturers, for example, must calculate the cost of production, and analyzing this measure can aid in the analysis and control of labor cost calculations.

The employee labor percentage is calculated in the same way, with the exception that you only add the labor cost calculations for the specific group of employees you're interested in.

The Significance of Labor Cost

The ability to successfully regulate the cost of labor is crucial for a small organization. Labor costs typically range from 20 to 35 percent of gross sales of labor cost calculations.

Employee percentages vary by industry; a service business may have a percentage of 50 percent or higher, whereas a factory must maintain a ratio below 30 percent.

Cutting labor costs, on the other hand, is a delicate balancing act. Payroll cuts that are too drastic can make it difficult to recruit and retain effective staff of labor cost calculations.

Effective labor cost control entails discovering cost-cutting opportunities without jeopardizing employee motivation or productivity.

Tips to Reduce Your Labor Costs

Keeping your labor expenditures under control is an important aspect of your company's expense management. This should not imply lowering staff compensation or cutting shortcuts on additional labor expenditures.

It does, however, necessitate being vigilant and establishing clear guidelines for attendance, overtime, and time reporting.

Get Time Tracking Right

Accurately tracking staff hours is one of the most significant techniques for lowering labor costs. Time tracking errors can have major and costly ramifications for your company.

Keep an Eye on Overtime Hours

Most of the additional labor expenditures, such as payroll taxes and benefits, are beyond your control.

You do, however, have control over your team's schedule. This implies you can control how many overtime hours your workers work.

Of course, there are times when overtime is unavoidable, but if you want to cut labor expenditures, keep it to a minimum.

How to pay the staff?

Learning how to pay your staff may seem difficult if you're a new business owner. You can't just hand them a wad of cash from your bank account, after all. You must keep legal records of every dollar that travels from your hands to theirs.

Different Types of Compensation

There are three main ways in which companies pay their workers:

•Hourly Compensatio n

Hourly pay is calculated on a per-hour basis. The amount of time an employee works during a pay period determines their salary. You may, for example, pay an associate $20 per hour for their services. They are owed $1,600 if they work 80 hours in a pay period.

A part-time employee or someone who does not have a steady schedule, such as a restaurant server, would benefit from an hourly wage.

Hourly workers are typically considered non-exempt, which means they are eligible for overtime compensation.

If you're still getting your firm up and running and figuring out how many employees you'll need and how often you'll need them, you can decide to pay a new hire an hourly wage.

•Salaried Compensation

Salaried personnel are paid a set amount each payday, which is calculated by dividing their annual wage by the number of pay periods.

With a $60,000 yearly salary and a bi-weekly pay period, for example, an employee will receive $2,307 in pre-tax wages per payday.

Salaries are most appropriate for corporate jobs where the employee's time contribution is predictable. Overtime pay is usually not available to salaried staff.

•Commission-Based Compensation

Employees can also be paid on a commission basis. They may be paid a low base rate, which could be hourly or salaried, with bonus compensation if they met predetermined sales targets .

A full-time salesperson at your organization, for example, might earn a base yearly pay of $35,000. They also get paid a commission depending on a proportion of the agreements they close.

Employees in sales roles benefit from commission-based income since it motivates them to achieve specific objectives.

To verify that you are properly rewarding your employees while complying with minimum wage and overtime requirements, see the FLSA.

How Much to Pay an Employee?

The amount you should pay your employees is determined by how much your competitors pay for similar jobs and the type of business you own.

Conduct market research to find out how much other companies in your area and location pay for the position you're hiring for or the type of labor you require.

As a small business, how do you pay an employee?

Set up payroll to begin paying personnel, and be sure to select a payroll system that makes sense to you.

Decide if you'll pay your staff weekly, biweekly, semimonthly, monthly, or on a different schedule entirely. After that, calculate your employees' gross salary for the pay period as follows:

Multiply the hourly rate by the number of hours worked during the pay period for hourly employees. Remember to remove any unscheduled time from your estimates if they took any unexpected time off.

Employees who are paid on a salary: Multiply their annual salary by the number of pay periods in your annual payroll plan.

Commission employees: Determine whether they are paid on an hourly or salaried basis. Then, based on your company's compensation structure, add their commission earnings for that pay period.

How to Pay an Employee?

•Calculate Net Pay

You've calculated your employees' gross salary and the amount of tax withheld from their paycheck. Subtract the amount deducted from their gross salary to arrive at their net pay.

For example, if an employee's gross compensation for the pay period is $2,500 and $680 in taxes must be withheld, the employee will receive $1,820 on payday.

•Paychecks should be distributed to your employees

It's now time to pay your employees their owed net compensation. The most common methods of paying an employee are checks and direct deposits.

If you use direct deposit, consult the bank details provided by your employees. Alternatively, you can have checks cut for employees by your bank or payroll provider.

•File Taxe s

Paying taxes on behalf of your W-2 employees is your responsibility. Take the part of the employee's paycheck that has been withheld and distribute it to the appropriate places for tax filings.

File taxes with the IRS, your state's tax collection agency, and the tax collection agency for your municipality. It's worth noting that some taxes are solely paid by the employer.

•Pay Into Benefits

The government will not receive all of the withheld salaries. A portion of your salary may go toward employee benefits, depending on your firm. Deposit into the appropriate accounts on behalf of your employees if you offer any employee benefits programs.

•Update Payroll Records

In the event of an audit, you'll need to retain your payroll records for several years. Maintain an up-to-date, well-organized, and easily accessible payroll register.Include details on who was paid, how long they worked, how much they were paid, and what taxes were deducted.

Best Payroll Solution for Small Businesses

Payroll appears to be a difficult task, doesn't it? How do small business owners deal with the situation?

Businesses at the enterprise level have in-house teams dedicated to paying personnel. Small firms may not be able to afford a payroll specialist or may not have enough employees to justify the labor cost calculations.

In the majority of cases, however, even one-person enterprises are responsible for labor law compliance and tax withholding.

In a small firm, payroll software is the most efficient way to pay staff. It saves both money and time. Payroll software automates every stage of the detailed payroll process we just went through, including payment distribution.

Paying a 1099 employee is as simple as paying them their gross wages. To put it another way, keep your standard payroll procedures in place but don't withhold their taxes.

1099 workers aren't officially employees. They are referred to as independent contractors.

It is the responsibility of independent contractors to pay their payroll taxes. They'll be responsible for filing all of their state and federal taxes part of labor cost calculations.

If the person paying for the work has control over the ultimate product or outcome but not over how the work is done, the person is classed as an independent contractor.

The contractor, not your company, would handle quarterly tax payments to the IRS and state and local governments. While you can pay independent contractors a set fee, you can't offer them a salary; otherwise, they'd be deemed non-exempt workers, and you'd have to provide them with a W-2.

If you're unsure whether someone is an employee or an independent contractor, you should seek legal advice from a lawyer who can explain how federal labor regulations relate to your business. You must ensure that you are paying your employees by the FLSA to avoid any potential litigation or legal difficulties.

How Deskera Can Assist You?

As a business, you must be diligent with employee leave management. Deskera People allows you to conveniently manage leave , attendance , payroll , and other expenses . Generating payslips for your employees is now easy as the platform also digitizes and automates HR processes.

Key Takeaways

• Labor expenditures must be appropriately accounted for by business owners who want to stay on budget and optimize earnings.
• Variable labor expenses fluctuate according to the entire amount of production output, as the name implies.
• If you don't know how much labour costs to produce your goods or services, you won't be able to price them correctly.
• Finally, assessing your labour costs might assist you in identifying revenue leaks that are eroding company profits.
• It's a little more complicated to calculate the overall cost of labour than just adding up the entire cost of all the payments.
• Keeping your labor expenditures under control is an important aspect of your company's expense management.
• It is the responsibility of independent contractors to pay their payroll taxes. They'll be responsible for filing all of their state and federal taxes

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Labor Costing

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

Get Any Financial Question Answered

Table of contents, what is labor costing.

Labor costing is the process of calculating the cost of labor for a product or service.

It is a crucial part of business operations and can significantly impact profitability. Labor costs are typically broken down into direct and indirect costs .

Different methods, techniques, and formulas are used to calculate labor costs.

Measurement of Labor Turnover

A high labor turnover rate can indicate several issues within a company, such as poor working conditions, low wages, or a lack of opportunities for advancement.

It can also be caused by factors outside of the company’s control, such as the overall economy or changes in the industry. Regardless of the cause, a high labor turnover rate can be costly for a company.

Three principal methods can be used to measure labor turnover:

Separation Method

This method considers the number of employees who leave the company divided by the average number of employees during the period.

The formula for separations rate is:

Labor turnover = (No. of separations in a period / Average no. of workers) x 100

LT = (NS / ANW) x 100

So if a company currently has 100 employees and ten leave during the year, the separation rate would be 10%.

Replacement Method

This method looks at the number of workers replaced during the month/year divided by the average number of employees during the period.

The formula for replacement rate is:

Labor turnover = (No. of replacements in a period / Average no. of workers) x 100

LT = (NR / ANW) x 100

For example, if a firm has 200 employees and ten are replaced during the year, the replacement rate would be 20%.

Flux Method

This method accounts for the number of employees who left and the number of new employees divided by the average number of employees during the period.

The formula for flux rate is:

Labor turnover = ((No. of separations + No. of replacements) / Average no. of workers) x 100

LT = ((NS + NR) / ANW) x 100

For instance, if a business has 1000 employees and a hundred of them leave and a hundred are replaced during the year, the flux rate would be 20%.

Labor Productivity

Labor productivity measures how much output (in terms of goods or services) is produced by one unit of labor input.

It is typically calculated as output per hour of work. Labor productivity can be measured at the level of an individual worker, a team, a department, a company, an industry, or even an economy.

Labor productivity = Output / Actual hours worked

Labor Costing per Unit

This method of labor costing assigns a specific cost to each unit produced. The total labor cost is then divided by the number of units produced to calculate the labor cost per unit.

Labor cost per unit = Direct wages / No. of units

Time Allowed

It is a period given to complete a task or work.

Standard time + Incentive allowance

Labor Efficiency

It measures how a given workforce efficiently accomplishes a task compared to the standard set in finishing certain tasks.

It is measured by dividing the actual output by the standard output multiplied by 100 to get the percentage. A higher percentage means higher efficiency.

Labor efficiency = (Actual output / Standard output) x 100

Time Rate Method

This is the most commonly used method in businesses to calculate the cost of labor. In this method, the labor cost is calculated by multiplying the time taken to complete a task by the hourly pay rate.

Earnings = Hours worked x Rate per hour

For example, if an employee takes 5 hours to complete a task and their hourly rate of pay is $10, then the cost of labor for that task would be $50.

Straight Rate Method

A type of wage system is known as payment by result. In this method, employees’ output (worker’s efficiency) will be multiplied by the rate per piece finished rather than the time involved in doing the work.

Earnings = Output x Rate per unit

For example, if an employee produces ten widgets in an hour and their rate per widget is $1, then the cost of labor for that task would be $10.

Differential Piece Rate System

It is a wage payment in which a worker gets a high piece rate for completing the job within the allotted time and a lower piece rate for completing the job beyond the allotted time.

F.W. Taylor's System

Fredrick Winslow Taylor developed this system. It follows the principle that the efficient worker is rewarded while the worker who performs below the standard gets penalized.

Here is how this method is calculated:

Earnings = 80% of price rate when below standard

Earnings = 120% of price rate when at or above standard

Merrick Differential Price Rate System

W.H. Merrick developed this system. It is similar to Taylor’s system with a slight variation. Instead of penalizing the worker, a lower differential price rate is paid for work done below the standard time.

Gantt Task Bonus Plan

Henry L. Gantt developed it. In this system, workers are given a bonus for completing the task before the deadline. The amount of bonus is generally a percentage of the wages earned.

Halsey Premium Plan

Halsey, Doolittle, and Emerson developed it. In this system, workers are given a bonus for completing the task before the deadline. The amount of bonus is generally a percentage of the wages earned.

In this system, he is paid a bonus of 50% for the time saved plus the salary for the actual time spent on the job.

The formula for this method is:

Earnings = (Hours worked x Rate per hour) + (Time saved x Rate per hour x 50%)

E = (HW x RH) + (TS x RH x 50%)

Halsey-Weir Plan

It is a modification of the Halsey premium plan. In this system, a standard time is determined, and if a worker saves time by finishing a job earlier, he is paid a bonus of 30%, plus wages for the actual time spent on the job.

Earnings = (Hours worked x Rate per hour) + (Time saved x Rate per hour x 30%)

E = (HW x RH) + (TS x RH x 30%)

Rowan System

In the Rowan system, if the time taken by the worker to finish the task is more than the set period, he is paid according to the time rate, but when the worker finishes the work earlier than the standard time; then he is entitled to a bonus along with the time wages.

Earnings = Hours worked x Rate per hour + (Time saved / time allowed x Hours worked x Per hour rate)

E = HW x RH + (TS / TA x HW x RH)

Barth Variable Sharing Plan

It was developed by Barth and Co. In this system, the time rate is not guaranteed, which means workers are not paid for the hours worked more than the standard hours.

Earnings = rate per hour x √(Standard hours x Hours worked)

E = RH x √(SH x HW)

Labor Costing FAQs

What is labor costing.

Labor Costing is the process of tracking and accounting for the wages and benefits associated with employing workers in a given organization or business. It involves understanding how wages, hours worked, overtime pay, bonuses, and other compensation affect profitability.

How do I calculate labor costs?

To calculate labor costs, you must determine an employee's hourly wage rate (including any overtime or bonus payments) and add relevant taxes, contributions to pension plans, health insurance premiums, and other employee-related expenses. Once these have been identified and calculated, total labor costs can be determined by multiplying the number of hours worked by each employee during a given period with their total wage rate.

What are the key components of Labor Costing?

The key components of Labor Costing include wages and salaries, overtime pay, bonuses and incentives, holiday pay, taxes, and contributions to pension plans or health insurance premiums. All of these factors must be taken into account when calculating labor costs.

What is the purpose of Labor Costing?

The purpose of Labor Costing is to accurately track and manage expenses associated with hiring employees to maximize profitability. By understanding how much each employee costs an organization over time, businesses can better allocate resources and optimize their workforce according to budget constraints while maintaining quality output.

How can I reduce labor costs?

There are several ways to reduce labor costs, including hiring temporary staff for specific projects instead of full-time employees, automating certain processes to reduce the amount of human labor needed, and using performance-based incentives to reward high-performing workers. Additionally, businesses can improve efficiency by restructuring their workforce and eliminating redundant or unnecessary roles.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

Related Topics

• Control-Factor Unit
• Cost Accumulation
• Difference Between Direct and Indirect Labor Cost
• Incentive Plans
• Labor Costing: Practical Questions With Answers
• Methods of Time-Keeping

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Last Updated: December 8, 2022 | Read Time: 14 min

Many organizations are feeling the pressure to do even more with less—fewer employees, fewer resources and smaller budgets. So, as an HR leader you might be wondering what you can do to confront the labor cost issue head-on and find solutions.

Labor costs can account for as much as 70% of total business costs; this includes employee wages, benefits, payroll and other related taxes. Yet, according to a Paycor survey, HR professionals only spend 15% of their time managing the cost of labor. 

However, keeping an eye on the annual operational costs (especially now) could help you prepare for the financial future. To be an asset as an HR leader, you need to think like a financial executive, but also be creative with ways of reducing costs.

How to Reduce Labor Costs During a Recession

As a recession sweeps the nation, many companies are left wondering how to reduce annual costs of labor without gutting their workforce. slashing employee hours, or making other unpopular decisions. 

While there is no one-size-fits-all answer to this question, there are a few strategies that can help you get started. Here are four tips for reducing labor expenses during a recession.

• Cut back on overtime If your employees are working more than 40 hours a week, consider cutting their hours back to 40. This will save your organization money on labor while still allowing your employees to earn a decent wage.
• Offer incentives for employees to work their allotted hours You could offer a bonus for employees who stay within their allotted hours. This will help to motivate your employees to work fewer hours, which will in turn cut costs.
• Carefully hire the right candidates from the beginning The average cost of turnover can cost up to 30% of an employee’s first-year wages, so this is an important strategy for reducing annual costs of labor in the long run.
• Use temp labor during busy times If you have peaks and valleys in your business, consider using temp labor during your busy times to help with the workload.

Having access to labor information allows you to plan for the future and help your organization make more informed decisions. Armed with the right data and advanced technologies, like Paycor’s Time & Attendance software, you can create a strategy to correct the problem and more easily predict when you might need additional staff in the future, which will enable better budget forecasting.

Which Industries Have The Highest Labor Costs?

A June 2022 report from the Bureau of Labor Statistics , showed the average cost of labor of 30 different industries in 2021 compared to 2020.

What’s interesting about this report is that we were at the height of COVID-19, and you’ll see some big changes. Travel Arrangement and reservation services went from 73.7% to -7.3%. And the air transportation industry had the highest increase in 2019 at 106.9%, and fell to 7.6% in 2021.

2023 Labor Costs

Salary budgets are the highest they’ve been in over 20 years. Why? Attracting high-quality talent is extremely competitive right now; and, inflation is at an all-time high, making the bump necessary. That’s why it’s important to know how to strategically establish salary ranges .

The Consumer Price Index increased 8.5 percent for the 12 months ending in July . This means that companies are having to revise their pay budgets.

According to Consultancy WTW’s July Salary Budget Planning Report :

• On average, companies are planning to increase pay by 4.1% in 2023.
• In 2022, the average pay increase was 4%.
• Inflation is at 8.5% at the time of this report.
• Around 96% of companies globally increased salaries (compared to 63% in 2020).

Employer labor expenses also include benefits. According to AON, average costs for employers in the U.S. will increase 6.5 percent to more than $13,800 per employee in 2023 . This is a huge jump from 2022 when the costs rose 3.7% from 2021.

How can HR & Finance Departments Work Better Together?

HR and finance teams can work better together if they take a walk in each others’ shoes. To start thinking like a CFO when approaching business expenses, you might want to start with these questions:

Are We Overspending on Labor?

Check overtime. There may be hidden costs that you need to watch out for.

According to a survey from Qualtrics , 57% of employees said they “want the opportunity to work overtime or extra shifts” to bring in more money as inflation continues to rise and we go into a recession.  

Are We Underutilizing Our Workforce?

If HR isn’t tapping into the full spectrum of talent in your company, you’re leaving money on the table. By not taking full advantage of your employee’s potential, disengagement and lack of motivation soon follow.

This can lead to a dramatic decrease in productivity and high turnover rates, which in turn can negatively impact your company’s bottom line.

Are We Accurately Capturing and Recording Time Worked?

HR can lead the way by championing a time management solution that accurately tracks and manages hourly workers, eliminates duplication errors, and reduces payroll losses.

Are We Looking At Labor Costs in Silos?

If you’re not adding non-employee (freelancers, contract workers, consultants) and contingent labor into the labor cost equation, your numbers will be way off.

You run the risk of potentially misclassifying employees and non-employees, which can result in harsh fines if the company is audited. 

Now that you are thinking like a CFO and working alongside them, it is important to understand labor expenses, what is normal, and how to optimize your company’s budget.

What is An Acceptable Labor Cost Percentage?

An acceptable average cost percentage is 25-35% of gross sales. This can vary greatly depending on the business, industry, and location. 

For example, a retail store in a small town may have labor percentages less than 25%, while the manufacturing sector may have labor percentages higher than 35%.

There are many factors that contribute to the total labor cost percentage for a business, including the type of business, the industry, the unit labor cost, location, and the number of employees. 

The type of work, and the wage rates can also affect the total labor cost percentage for employees.

What Percent of A Business’ Costs Are Labor?

The percentage varies, but labor costs include employee’s salaries, cost of benefits, and taxes. They are often broken up into direct costs and indirect costs.

The sales price of a product or service takes into account the labor costs, and any other overhead expenses, including materials. When these prime costs are taken into consideration, then they are able to see if the cost of labor is too high or too low.

If the company has to lower its prices, then they are going to have to cut labor costs as well so that they are not running in the negative.

The restaurant labor costs are lower as many of the staff receives tips, and the lower wages reduce the cost.

Direct Costs vs. Indirect Labor Costs

Direct costs are tied to the production of a product or service such as a production line worker in the manufacturing sector, or a salesperson.

Indirect labor costs are not tied to production and could be classified as someone in security.

Fixed vs. Variable Costs

Salaries paid to your workforce are fixed annual costs, as they don’t change based on production.

Over time, temporary staffing, commissions, and bonuses are all considered variable labor costs since they will change depending on many different factors.

Variable cost is often hard to predict, but it’s an important component of determining your company’s annual labor cost. In the manufacturing sector, the costs are variable as the output of machines can change.

Labor Cost Percentage Formula

Calculating labor costs is pretty straightforward. To find your labor cost percentage, divide your labor cost by gross sales and multiply by 100.

Labor Cost Percentage = (Total Labor Cost / Total Gross Sales) x 100

Be sure to include the cost of all bonuses, commissions, benefits, and all taxes you pay.

For example: If your labor costs total $250,000 and gross sales equal $500,000, the labor cost formula would look like this: 250,000 ÷ 500,000 x 100 = 50%.

How Paycor Helps

Having a good understanding of your current labor costs and trends is essential for keeping spending in check. Companies that integrate disruptive, HR advanced technologies will increase revenue and productivity by up to 9% while lowering HR costs by 7% (HBR). Whether you are in the manufacturing sector or the airline industry, your CFO will really like the sound of those statistics.  Paycor Analytics can help. Discover how our simple reporting provides insight into hours and costs to optimize your spending.

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How Is Labor Cost Calculated: A Simple Guide

Ralitsa Golemanova

Whether you’re running a restaurant, a construction company, or another small business with employees, labor costs are some of the biggest expenses you'll need to cover. 

That’s why it’s essential to understand what labor costs are and how they are determined. Labor cost does not only mean the hourly rate that you pay a member of your staff . It spans a number of other expenses that you need to account for. Only after factoring them in you can get the actual labor expenses for your company. 

How is labor cost calculated, then? Read on to get a clear overview and make the right calculations for your business.  

What Is Labor Cost?

The expenses that you pay for each employee equal your labor cost for that particular staff member. 

Labor cost includes gross wages for an employee , as well as additional payments on their behalf, like Social Security and Medicare taxes, as well as benefits. 

You have to keep tabs on your labor expenses and to constantly compare them to your revenue, so that employee costs don’t harm your bottom-line . This is called labor cost percentage and is the key to solid business management and growth.  

How Is Labor Cost Calculated?

In order to calculate the labor cost of an employee per hour, you need to go through a simple process of factoring in all expenses related to their employment. 

The simple labor cost per hour formula looks like this:

Labor cost per hour = (gross pay + all annual costs) / actual worked hours per year

Let’s break down each of these calculations into steps. 

We’ll use a hypothetical  employee, Maria, as an example. She is an hourly, non-exempt employee, who works full-time in a company in California with more than 26 employees. She gets the minimum wage of $13. 

So, how do you calculate the labor cost for Maria? 

#1. Calculate the Gross Pay

The first thing you want figure out is the gross pay of an employee.  

Here is the formula:

Gross pay = gross hourly rate x number of hours worked for a pay period

In this case, let’s calculate Maria’s gross pay per year. The total hours that Maria is supposed to work for the period of one year is:

Total number of hours per year = 40 hours per week x 52 weeks = 2080 hours

This means that her gross pay per year is: 

$27,040 = $13 x 2080 hours

#2. Figure Out the Actual Worked Hours 

The total work hours per year are 2080. However, every employee needs to take days off. 

Let’s say that Maria did not work 12 days in that year. Here is how to calculate hours not worked:

Hours not worked = 12 days x 8 hours = 96 hours

Then you can easily get the net hours worked:

Actual worked hours = total number of hours per year - hours not worked

This would mean, in this case:

1984 hours = 2080 hours - 96 hours

The actual hours that Maria has worked for a year are 1984 hours. 

#3. Determine All Annual Costs Per Employee

Next, you have to take into account all related expenses that you owe for Maria, such as taxes and healthcare. They come on top of her gross pay. Only after you calculate them can you get the actual labor cost per hour for a particular staff member, or the true cost per hour. 

Some typical labor costs besides the actual pay to the employee are:

Payroll Taxes:

• FICA taxes (7.65%), of which Social Security is 6.2% and Medicare is 1.45%
• FUTA taxes (standard rate of 6%, but exceptions apply)
• State unemployment taxes
• Local unemployment taxes 

Employee Benefits:

• Health insurance
• Additional insurance such as dental, life or disability
• Retirement plans
• Paid time off (sick and vacation days) 
• Meals at work
• Education and training 

Other Possible Expenses:

• Overtime pay
• Workers’ compensation insurance
• Work supplies

In Maria’s case, here is the breakdown of additional labor costs:

• $2,348.56 annual taxes: 6.2% Social Security is $1676.48, 1.45% Medicare is $392.08, 0.6% FUTA on the first $7,000 is $42, and California state unemployment insurance is 3.4% on the first $7,000, which equals $238   
• $3,120 health insurance
• $1,200 benefits
• $500 overtime 

Thus, the extra annual costs that you have to pay for having Maria in your team are $7,668.56. Of course, this is just an example and these costs can vary greatly. 

#4. Calculate the Total Annual Payroll Cost

You are now ready to determine the actual annual payroll cost for Maria, or the total labor cost for her. Here is how to do that:

Annual payroll cost = gross pay + other annual costs

In this example, the amount is:

$34,708.56 = $27,040 + $7,668.56

This is the total cost of Maria’s work for your business per year. 

#5. Calculate the Hourly Labor Cost

At last, you can figure out Maria’s cost of labor per hour. 

Her hourly labor rate (wage) is $13. However, you want to get the total cost per hour. Here is how you can do that:

Hourly labor cost = annual payroll cost / actual hours worked

For Maria, our hourly labor cost calculator comes up with the following:

$17.50 per hour = $34,708.56 / 1984 hours

Now you know the actual labor cost per hour for hiring Maria.

Determine Your Labor Cost Percentage

Knowing your labor cost expenses per employee is necessary for determining your labor cost percentage , which shows you the relationship between your total revenue for a given period and your labor costs during that time. 

The formula is:

Labor cost percentage = labor costs for all employees / total revenue 

When you determine your labor cost percentage, you can make a deeper analysis of your employee expenses. That’s how you can figure out if you need to reduce them to increase your overall profit margins . 

The average labor cost percentage should typically be in the range of 20% to 35% of a company’s gross sales. However, there are variations, depending on your field. It’s not uncommon for restaurants and other service businesses to have a labor cost percentage of up to 50%. In other areas, such as heavy industry, the percentage should not be more than 30% to ensure profitability.  

Tips to Reduce Your Labor Costs 

Keeping your labor costs under control is a large part of the expense management for your business. This does not mean reducing employee wages and cutting corners when it comes to the extra labor costs. However, it does entail being observant and setting clear rules regarding attendance, overtime and logging of worked hours .  

Get Time Tracking Right 

One of the most important tips for decreasing your labor expenses is to accurately track employee hours . Mistakes in time tracking can have serious and costly consequences for your business. 

With solutions like Hourly, you can be sure that clocking in and out for your employees is seamless , and that you get the most accurate information about their actual worked hours. The platform offers geofencing, which is great for teams on the go, as you can set the physical area in which employees can track time. 

Keep an Eye on Overtime Hours 

You cannot do much about reducing most of the additional labor costs, such as payroll taxes and benefits. 

However, you have control over the scheduling of your team. This means you can regulate the overtime hours that your employees are working. There are situations when you can’t avoid overtime, of course, but try to keep it at a minimum if you want to reduce labor costs. 

Keep Track of Labor Costs for Your Business

Staying on top of labor cost calculations and monitoring labor expenses are essential for running a successful company, whatever industry you’re in. 

If you’re ready to take your internal operations to the next level, Hourly can help. Our platform combines the top features that you need in your day-to-day business management. From time tracking and payroll to workers’ comp and meeting payroll records requirements , we’ve got your back. 

Want to get started? Just download the Hourly app on your mobile device.

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Understanding Labor Cost and Its Implications for Businesses

In today’s dynamic economic landscape, where businesses are constantly seeking ways to enhance competitiveness and profitability, one of the most critical aspects of financial management is the understanding and management of labor costs. Labor costs play a pivotal role in determining a company’s financial health, pricing strategies, profitability, and overall competitive advantage. In this comprehensive article, we will delve into the definition and calculation of labor costs, explore the various factors that influence them, and discuss their profound implications for businesses. Additionally, we will examine effective strategies for managing and reducing labor costs while maintaining a balance between cost efficiency, quality, and legal compliance.

Definition of Labor Cost

What is labor cost.

In a business context, labor cost encompasses the total financial outlay associated with employee compensation. It goes beyond the direct salaries and wages paid to employees and includes a range of supplementary costs. These supplementary costs comprise health benefits, social security contributions, pension funds, and any other related payroll taxes. Labor costs represent a significant portion of a company’s operating expenses, making them a focal point in financial management and strategic planning.

Why it matters?

The significance of labor costs extends beyond mere financial considerations. It has far-reaching implications for compliance with labor laws and financial reporting standards. Mismanagement or inaccuracies in labor cost calculation can lead to legal disputes, financial penalties, and damage to the company’s reputation. Furthermore, labor costs directly impact a company’s pricing strategies, profitability, and competitive positioning in the market. Effective labor cost management is not only crucial for the company’s bottom line but also for ensuring sustainable business growth and compliance with regulatory requirements.

Breaking Down Labor Cost

Direct labor costs.

Direct labor costs are explicitly tied to the creation or production of goods and services. These costs are directly attributable to specific operational activities, making them an integral part of product costing and pricing strategies.

In production, direct labor costs are closely monitored as they significantly affect the cost of goods sold and, consequently, the pricing structure of products. They also influence decisions regarding production methods, automation, and labor allocation

For instance, in the automotive industry, the wages of assembly line workers who assemble cars are direct labor costs. These costs are meticulously calculated to ensure competitive pricing and profitability.

The proper allocation of direct labor costs is crucial for accurate product costing, pricing decisions, and financial reporting. Failure to accurately account for these costs can lead to skewed financial statements and potential legal ramifications.

Indirect Labor Costs

Indirect labor costs encompass the expenses related to personnel who support the production process but do not directly contribute to the manufacture of specific products or services. These costs are less visible but equally important for business operations. This includes the salaries of administrative staff, facility maintenance personnel, and the human resources department, among others.

Indirect labor costs affect a company’s overall budgeting and financial planning. Efficient management of these costs is vital for maintaining profitability and ensuring operational efficiency.

How to Calculate Labor Costs

Calculating labor costs is a fundamental aspect of financial management in businesses. The basic formula for this calculation is:

Total Labor Cost = Direct Costs + Indirect Costs

Introduction to the Basic Labor Cost Formula

Direct Costs . These are the wages paid directly for manufacturing a product or providing a service. It includes hourly wages, salaries, bonuses, and commissions.

Indirect Costs . These are costs not directly tied to a specific product or service but necessary for the business’s overall functioning. This includes salaries for administrative staff, training costs, and employee benefits.

Simple Examples

Example 1: A factory employs workers for manufacturing, paying them a total of $50,000 (direct costs). The administrative and supporting staff salaries sum up to $20,000 (indirect costs). The total labor cost is $50,000 (direct) + $20,000 (indirect) = $70,000.

Example 2: A retail store pays its sales staff $30,000 and spends $10,000 on other employee-related expenses. The total labor cost would be $30,000 + $10,000 = $40,000.

In addition to the basic formula, it is important to consider the impact of external factors on labor costs. For instance, economic conditions like inflation can increase the cost of living, subsequently pushing up wage demands. Industry-specific demands also play a crucial role; for example, in tech industries, the high demand for specialized skills can significantly raise direct labor costs

The Importance of Understanding Labor Costs

Impact on pricing.

• The Direct Link. The cost of labor directly influences the pricing of products and services. Higher labor costs can lead to higher product prices to maintain profit margins.
• Customer Response. Pricing strategies affect customer behavior. If labor costs drive prices too high, it may reduce demand, affecting sales and profitability.

Proportion in Total Expenses

• Expense Breakdown. Labor costs typically constitute a significant portion of total business expenses. Understanding this breakdown is crucial for budgeting and financial planning.
• Variability Factor. Labor costs can vary based on seasonality, market demand, and changes in production levels, affecting overall business expenses.

Competitive Edge in the Market

Cost Efficiency. Efficient management of labor costs can provide a competitive edge by enabling lower product prices or higher investment in quality and innovation.

Quality vs. Cost. Balancing labor costs and quality is critical. Cutting labor costs too much may affect product quality, while high labor costs can lead to pricing challenges in competitive markets.

Labor costs not only affect a company’s balance sheet but also influence strategic decisions. For example, a business may decide to relocate operations to a region with lower labor costs. However, this must be balanced against potential impacts on product quality and employee morale. A detailed examination of how labor costs affected the profitability and strategic decisions in different businesses, such as manufacturing and retail, can offer deeper insights into their importance.

Unpacking the Factors Influencing Labor Cost

Understanding the various factors that influence labor costs is crucial for effective business management. These factors include:

Worker Availability . The supply of skilled labor in the market directly impacts labor costs. A scarcity of skilled workers can drive up wages, while a surplus may lead to lower costs.

Location . Geographic location affects labor costs due to varying living costs, availability of talent, and economic conditions. Urban areas generally have higher labor costs compared to rural locations.

Task Difficulty. Jobs requiring specialized skills or high-risk tasks often command higher wages, influencing the overall labor costs.

Efficiency. The efficiency of the workforce impacts labor costs. Higher productivity can lead to cost savings, while inefficiency can increase costs due to overtime and lowered output.

Legislation. Legal requirements like minimum wage laws, overtime pay, and benefits mandates significantly impact labor costs. Compliance with labor laws is essential to avoid legal ramifications.

Each factor impacting labor costs can have a substantial effect. For example, in urban areas where the cost of living is high, businesses may face higher wage demands. Conversely, in rural areas, the availability of labor might be less, but the cost could be lower. The complexity of tasks also dictates labor costs – specialized tasks require higher compensation. Furthermore, the efficiency of the workforce is crucial; more efficient workers reduce the need for a larger workforce, thereby reducing costs.

Strategies to Manage and Reduce Labor Costs

To optimize labor costs, businesses can employ various strategies:

• Automate to Increase Efficiency. Implementing automation in repetitive and routine tasks can reduce the need for manual labor, thereby lowering labor costs.
• Optimize Employee Scheduling. Effective scheduling can reduce overtime costs and ensure that staffing levels are aligned with business needs.
• Enhance Workforce Productivity . Training and development initiatives can improve employee productivity, reducing the need for additional staffing.
• Outsource Non-Core Functions. Outsourcing non-essential functions to third-party vendors can result in cost savings, as it often comes with lower associated labor costs.

When implementing strategies like automation, it’s vital to consider the initial investment costs against long-term savings. Effective employee scheduling can prevent unnecessary overtime costs, which can balloon labor expenses. Enhancing workforce productivity isn’t just about training; it involves creating an environment where employees can thrive and be more productive. Outsourcing can be a double-edged sword; it might reduce costs but can also impact the quality of services or products.

Understanding and managing labor costs is vital for the success of any business operation. It’s essential for businesses to stay informed about labor market trends and adjust their strategies accordingly to maintain competitiveness and profitability. Balancing cost efficiency with quality and legal compliance remains a key challenge in labor cost management.

In today’s complex business environment, where every dollar counts, effective labor cost management can be a differentiating factor between success and failure. Therefore, businesses must not only calculate labor costs accurately but also develop strategies that optimize these costs while ensuring that they comply with legal requirements and maintain product quality. With the right approach to labor cost management, businesses can navigate the challenges of the modern economy and position themselves for sustainable growth and success.

For any inquiries or uncertainties regarding labor cost management and legal compliance, our team of seasoned corporate attorneys stands ready to provide expert guidance and assistance. Reach out to us at [email protected] to explore how we can assist your business in effectively managing labor costs and ensuring legal compliance in today’s competitive landscape.

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11 Tips to Control Your Labor Cost & Boost Productivity

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By: Jay Mittelman

The money paid out to workers for their services is the biggest expense of any business. It can account for as much as  70 percent of total spending. These costs will only rise; U.S. wages for hourly workers have increased steadily over the last several years and are predicted to continue on the same trajectory. At the same time, the data shows that business owners feel they lack control over their profit margins. When asked how they plan to gain control, they cite curtailing labor cost as their primary method.

The phrase “controlling labor cost” often conjures up images of cutting costs across the board, reducing wages, and firing employees. Yes, these would all lower overall costs for a company, but they are drastic actions that should only be taken when absolutely necessary. And, of course, products and services offered to customers will suffer, which, in turn, means sales will suffer.

You likely feel that same pressure to reduce the labor budget for your enterprise. So, how can a business owner tackle labor cost strategically and optimize operations without rocking the boat?

Here are 11 tips for controlling labor costs and boosting employee productivity. These strategies are designed to strengthen your company instead of weakening it, preparing it for new growth. Employee morale and productivity will improve and you will gain increased visibility into your spending, including how it is put to use. Keep in mind that streamlined, comprehensive time and labor software and solutions are a key part of staying on top of labor costs.

Tip #1: Know Your Labor Burden Rate

To curb your labor expenses, you’ll need to have an accurate picture of what you’re paying each employee, beyond their basic salary or hourly rate. This total amount is known as your labor burden rate.  

To arrive at the annual labor burden rate for each employee, add their annual salary or hourly wages, any extra compensation such as overtime and bonuses, your share of payroll taxes and mandatory insurances for the employee, and your portion of fringe benefits—such as 401(k) match and health insurance contributions.

Knowing the exact cost of each employee can help you detect and fix hidden areas of overspending.

Tip #2: Optimize Employee Scheduling

With a clear schedule in place, everyone knows what to expect from their paychecks. This is also a helpful reference in targeting and eliminating extra overtime. For the staff running this restaurant , for example, monetizing their product led to a clearer understanding of labor cost and how much the restaurant gains from a single hour of work.

By understanding what each work hour entails, you’ll know how much is needed from your employees in order for you to stay in the black. If you have staffers who would be receptive to working 4 days a week instead of 5 days for better home-life balance, consider the advantages and the savings. It may also be worth reevaluating your telecommuting permissions, since working from home does create some minor savings.

Tip #3: Reduce Perquisites (“Perks”)

One way to directly curb your labor burden is to reduce Perquisites commonly referred to as "Perks", or reducing employer voluntary benefits, such as health insurance, flexible spending accounts, and retirement plans. You can make adjustments so that workers pay a slightly higher deductible, or you might convert pension plans to profit-sharing plans. Try to create an impact across the board; management and the C-suite should be included. Targeting people on the bottom rungs of the ladder and leaving the higher-ups unscathed will sour relations with your staff.

Tip #4: Change Vacation Options

According to a study conducted by Harris Interactive, 54 percent of U.S. adults say they are expected to work while on vacation . In such cases, the vacation isn’t truly a getaway. As a result, a small percentage of companies have been experimenting with unlimited time off. In return, the expectation is that some work will be completed even while the employee is away or out of town. Bigger companies in the public eye such as Netflix are doing it, and so are smaller companies. In most cases, the positives of this strategy appear to outweigh the negatives, but not all the votes are in yet.  

If this doesn’t seem like a realistic option to you, consider combining vacation and sick leave . Placing all time away from the office in one PTO bucket encourages autonomy, demonstrates greater trust, decreases leave-administration costs, and gives employees more flexibility, thereby increasing productivity at work.

Tip #5: Study Communications Between Departments

Is your HR team overlapping with accounting? Is Marketing performing tasks that are better left to the folks in Sales? Are two people in the same department doing the same tasks without realizing it? While not uncommon, this “doubling up” of duties is a waste of money. Establish a review process to make sure each job is only being tackled once.

hbspt.cta._relativeUrls=true;hbspt.cta.load(7873124, 'eb0c8105-5feb-4d08-ba00-0657fc179e32', {"useNewLoader":"true","region":"na1"}); Tip #6: Boost Productivity

Is your technology up to date? Are your employees properly trained? By supplying top-notch resources you automatically rein in labor costs and reduce employee turnover.

Tip #7: Work Overtime Before Hiring New Employees

If the applicant pool for your open position isn’t qualified enough to make a hire, it will cost less in the long run to pay your existing staffers overtime instead of hiring someone who isn’t qualified enough. Overtime is the more affordable choice in this scenario rather than making a “ panic hire .”

Tip #8: Become Agile

It isn’t just a catchphrase. The agile philosophy focuses on turning big or near-impossible problems into multi-step journeys with reachable goals.

Tip #9: Focus on Employee Retention

Attracting and keeping the right people in-house must start at the very beginning. Improve employee retention by implementing comprehensive applicant searches and training. Ensure people are in the right seats doing the right jobs, and that they are happy with their managers. In the book First, Break All the Rules , Gallup interviewed a million employees and 80,000 managers, and found that job satisfaction was linked, first and foremost, to the employee’s ability as a manager.

Tip #10: Cross-train Employees

Teaching someone a new skill set keeps the job interesting. Cross-training also increases a worker’s intrinsic value to your enterprise and assists with coverage when people are out sick or leave unexpectedly.

Tip #11: Automate and Outsource Tasks

Review your procedures and upgrade where possible. The right software and services partner can help to reduce labor costs within a matter of days or weeks. For example, by automating scheduling, a manager can quickly obtain insights into work habits through automated data reports.

Conquering Labor Cost Challenges

Controlling labor costs is not about swinging the axe and eliminating staff. It is also not about ditching commission or freezing wages. Instead, take a hard look at the variables directly influencing the rates of labor cost spending and consider restructuring for the sake of efficiency.

This means that when labor costs change—as they do on a regular basis—the business can make accommodations instead of moving into costly crisis mode. Read more about the time and labor solutions from Excelforce.

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What Are Examples of Labor Cost?

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What Is SAG in Accounting?

Comparison of labor price variance vs. labor efficiency variance, the importance of overhead costs.

• What Events Cause Debits to Be Recorded in a Factory Overhead Account?
• What Percentage of Business Overhead Should Be Payroll?

Labor cost is a critical factor in small-business operations. It's common for a business owner to hire employees to perform specific duties essential to the business – especially as it grows. There are various types of business labor, and each business labor expense can be assigned to one of them for cost-accounting purposes.

Most managers use accounting software to calculate the cost of goods produced or sold by the company and for its ease of use for a specific analysis of both direct and indirect labor costs. The four types of labor costs are variable labor, fixed labor, direct labor and indirect labor.

Variable Labor

As the name implies, variable labor costs vary based on the total amount of production output. The most common type of variable labor for small businesses is hourly employees. Consider the retail stores where you shop and the restaurants in which you dine. As demand for these businesses increases or decreases, the variable labor costs fluctuate commensurately.

While these employees are usually hired directly, some companies engage a temporary employment agency to find and hire new variable labor employees. Small businesses tend to use variable labor employees to minimize labor costs so that wages do not exceed estimated revenue. It's rare for business owners to guarantee working hours to these employees since they typically prefer to retain the right to cut back hours when sales and production output decreases.

Fixed Labor

Fixed labor costs remain the same despite fluctuations in a company's production output, according to the Small Business Administration (SBA). Owners and employees who earn a fixed salary regardless of total hours worked are obvious examples of fixed labor costs. One benefit of fixed labor costs is that business owners avoid paying overtime to managerial and supervisory staff. On the other hand, it's usually challenging to lower fixed labor costs without compromising the efficiency or efficacy of business operations.

Direct Labor

Direct expenses are costs that are connected to a specific cost object, such as raw materials used to develop a specific product or software implemented to quality control a consumer good or service. The majority of direct costs are labor and direct materials. According to the Financial Accounting Standards Board (FASB), which is the authority on nongovernmental generally accepted accounting principles (GAAP), variable and fixed labor costs can be categorized as direct or indirect.

Direct labor includes all employees responsible for producing a company’s products or services. Some examples of direct labor include quality control engineers, assembly line workers, production managers and delivery truck drivers. Unlike indirect labor, direct labor encompasses costs that are allocated to each consumer good or service produced by a company. Direct labor is typically managed through the use of specific time clock codes that can be aligned to individual production departments to calculate a portion of the cost of goods sold.

Indirect Labor

Costs that cannot be traced to an individual product or service or are otherwise labor expenses that are shared across the organization, such as administrative role expenses, are defined as indirect labor. Other examples include office supervisors, accountants, sales team members, maintenance staff and administrative assistants.

While indirect labor is a contributor to a company's indirect manufacturing overhead, it is a type of labor cost that is not allocated to the company's products or services because it affects the entire organization. Since employees provide ancillary services to the company's overall production process, this labor cost cannot be assigned to a specific product or service as with direct labor costs. It's important to note that business owners must pay for indirect labor through gross profits from product sales.

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Liz Scavnicky is a marketing maven with over two decades of interactive marketing, copywriting, business development and project management experience. Liz has served myriad clients not limited to Best Buy, Dell, Discover, General Mills, General Motors, Microsoft, Target, UPS Store, Viacom, Visa, and Yahoo! Her sweet spot is small and medium-sized businesses thanks to her passion for entrepreneurship and disruptive technologies. A formal Dale Carnegie instructor, she thrives on helping others reach their ultimate potential. A globe-trotter who travels internationally frequently for business and pleasure, Liz studied abroad for her undergraduate and graduate degrees, at the University of Montpellier (France) and Hong Kong Baptist University, respectively.

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15 Strategies to Manage and Reduce Labor Costs

Alex Padalka

CEO at JetBase

In an environment of evolving market dynamics and intense competition, managing and reducing labor costs is crucial for maintaining business viability and ensuring sustained growth. For businesses spanning various industries and sizes, fine-tuning labor costs is an integral aspect of bolstering operational efficacy and securing financial health.

What Defines Labor Costs?

So, let's start by understanding labor costs before we dive into how to reduce labor costs. They represent the cumulative expenses a company incurs to employ its workforce, including salaries, wages, benefits, and payroll taxes, along with any other expenses related to employee compensation. They are one of the most significant components of a company’s overall expenses, making their effective management indispensable for maintaining budgetary equilibrium and securing long-term fiscal stability.

At JetBase , we recognize the paramount importance of meticulous labor cost management for companies aspiring to bolster their competitive standing. Especially in sectors where labor is a major contributor to overall operational costs, balancing cost reduction with employee satisfaction is imperative. This equilibrium is vital not only for sustaining high-quality product and service delivery but also for cultivating a harmonious and productive work environment.

Through our journey in software outsourcing, we have assimilated a wealth of knowledge on labor cost optimization, learning that a strategic, balanced approach is the cornerstone for achieving enhanced productivity, cost efficiency, and employee morale.

Factors That Affect Your Labor Costs

Understanding the multitude of elements influencing labor costs is foundational for any effective management and reduction strategy. Several factors, both internal and external, can substantially impact the labor costs within a company.

At JetBase, we emphasize the importance of recognizing these components to craft comprehensive and informed strategies for optimal labor cost management. Below are some factors that will help you understand how to control labor cost.

Proven Strategies to Reduce Labor Costs Effectively

Effectively reducing labor costs is an intricate balance between managing expenses and maintaining a content and productive workforce. It is very important to manage labor costs no matter if you are a startup or a giant in the market and that is why we have cultivated a suite of strategies to optimize labor costs without compromising the quality of work or employee satisfaction.

1. Avoid Overtime

Encouraging a focus on completing tasks within the standard work hours is crucial. Efficient time management and workload organization can minimize the need for overtime, reducing the extra costs incurred from paying employees at premium rates for additional hours worked.

2. Optimize Efficiency

By refining operational processes and fostering a productive and responsible work culture, the time required to accomplish tasks can be significantly reduced. This optimization not only enhances overall efficiency but also directly decreases labor costs, allowing resources to be allocated more effectively.

3. Flexibility in Work Schedules

Providing employees with flexible working arrangements can lead to enhanced job satisfaction and optimized productivity levels. This flexibility can also reduce the necessity for additional staff during peak operational times, ultimately helping in controlling labor expenditures.

4. Consider Commissions

Incorporating commissions into compensation structures can boost employee motivation and performance by creating a direct correlation between effort and earnings. This strategy can help manage labor costs effectively by aligning them more closely with revenue generation and organizational success.

5. Enhance Company Culture

Establishing a positive, inclusive, and transparent company culture is vital. It can lead to heightened employee morale and reduced turnover rates, thereby minimizing the costs associated with recruiting and training new staff, ensuring a harmonious and productive workplace.

6. Automation and Outsourcing

Leveraging automation for mundane and repetitive tasks and outsourcing tasks that are not core to the business can optimize the allocation of human resources. It allows focus and expenditure on areas where human input is most valuable and essential, reducing overall labor costs.

7. Revise Compensation Packages

Regularly revisiting and adjusting compensation packages can maintain competitiveness and ensure alignment with both employee performance and organizational financial stability. This alignment is critical in managing labor costs and retaining top talent in a competitive market.

8. Rethink Perks and Benefits

Offering valuable but cost-effective perks can increase employee loyalty and retention. By reassessing and tailoring benefits packages to employee needs and organizational capacities, companies can manage labor costs more efficiently without compromising on employee well-being.

9. Cross-Training: A Multi-Skilled Workforce

Investing in employee development through cross-training in various roles and skills increases workforce adaptability. This multi-skilling reduces reliance on specific individuals and allows for more versatile deployment of staff, optimizing operational efficiency and helping control labor costs.

10. Minimize Turnover

Developing strategies to increase employee retention is crucial in reducing the substantial costs related to high turnover, including recruitment, training, and lost productivity. A focus on employee engagement and job satisfaction can help in maintaining a stable and experienced workforce.

11. Implement Predictable Schedules

Establishing stable and predictable work schedules enhances employee satisfaction and enables more accurate workforce planning. It prevents overstaffing or understaffing issues, ensuring that labor costs are aligned with business needs and operational demands.

12. Embrace Part-time and Freelance Workforces

The integration of part-time and freelance employees can offer flexibility in workforce management and potentially lower labor costs related to benefits and contractual obligations, allowing organizations to scale their workforce according to their fluctuating needs efficiently.

13. Consider Variable Pay Structures

Incorporating variable pay structures that align with performance and the financial health of the organization can balance employee compensation with business realities. It enables a more adaptive approach to labor cost management, ensuring sustainability and competitiveness.

14. Eliminate Conflicts and Enhance Productivity

Timely resolution of workplace conflicts is essential to maintain a cohesive and productive work environment. By fostering harmonious employee relations, disruptions are minimized, leading to optimized productivity and more effective labor cost management.

15. Utilizing an Outsourced Team

Leveraging an outsourced team like JetBase can offer critical advantages and cost savings for a company. Outsourcing enables organizations to focus their internal resources more efficiently on core business activities. The external team takes on the substantial time and resource investments typically associated with training and hiring, ensuring that each member is proficient and well-equipped to perform their tasks efficiently. This arrangement relieves the company from the extensive costs and efforts involved in these processes, fostering enhanced operational productivity and significant value addition, while allowing organizations to concentrate more on strategic objectives and essential operations.

By meticulously implementing these strategies, organizations can achieve a significant reduction in labor costs while maintaining a satisfied and productive workforce, ensuring long-term sustainability and success.

Customizing Strategies to Your Business Needs

It is crucial for businesses to align labor cost management strategies with their unique operational needs, organizational culture, and business objectives. A one-size-fits-all approach can be detrimental, leading to dissatisfaction among employees and potential harm to the business in the long run. Companies need to assess their specific circumstances, evaluate their workforce needs and preferences, and customize strategies to create a balanced, sustainable approach to managing labor costs.

By focusing on individual organizational needs and employee satisfaction, companies can adopt a holistic approach to labor cost management, ensuring a harmonious, productive work environment and a mutually beneficial relationship between employers and employees. It allows companies to maintain high levels of employee morale and productivity while keeping labor costs in check, ultimately contributing to the overall success and sustainability of the business.

Still wondering why and how to cut labor costs? Well, managing and reducing labor costs is pivotal for the sustainability and success of any business. Each organization must approach labor cost management strategically, focusing on optimization and efficiency, without compromising on the quality of work life for employees. Implementing strategies like optimizing efficiency, embracing flexible work schedules, enhancing company culture, and leveraging outsourced teams, companies can strike a balance between employee satisfaction and cost management.

In every strategy adopted, whether it's revising compensation packages or embracing automation and outsourcing, customization to fit the specific needs and context of the organization is paramount. By doing so, organizations can navigate the delicate balance between maintaining a motivated, productive workforce and ensuring the financial health and sustainability of the business.

Through careful and thoughtful implementation of these strategies, JetBase can ensure it is not only reducing unnecessary expenses but also fostering an environment conducive to growth, innovation, and long-term success. Balancing labor costs with employee needs and business objectives leads to a harmonious and prosperous organizational ecosystem, paving the way for enduring success in the competitive business landscape.

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Calculate your startup costs

Calculate your business startup costs before you launch.

The key to a successful business is preparation. Before your business opens its doors, you’ll have bills to pay. Understanding your expenses will help you launch successfully.

Calculating startup costs helps you:

• Estimate profits
• Conduct a break-even analysis
• Secure loans
• Attract investors
• Save money with tax deductions

Break-Even Analysis Calculator

Use this calculator to discover your break-even point and determine your future profits.

Identify your startup expenses

Most businesses fall into one of three categories: brick-and-mortar businesses, online businesses, and service providers. You’ll face different startup expenses depending on your business type.

Brick and mortar

There are common startup costs you’re likely to have no matter what. Look through the following list, and make sure to add any other expenses that are unique to your business:

• Office space
• Equipment and supplies
• Communications
• Licenses and permits
• Lawyer and accountant
• Employee salaries
• Advertising and marketing
• Market research
• Printed marketing materials
• Making a website

Estimate how much your expenses will cost

Once you have your list of expenses, you can estimate how much they’ll actually cost. This process will be different for each expense you have.

Some expenses will have well-defined costs — permits and licenses tend to have clear, published costs. You might have to estimate other costs that are less certain, like employee salaries. Look online and talk directly to mentors, vendors, and service providers to see what similar companies pay for expenses.

Add up your expenses for a full financial picture

Once you’ve identified your business expenses and how much they’ll cost, you should organize your expenses into one-time expenses and monthly expenses.

One-time expenses are the initial costs needed to start the business. Buying major equipment, hiring a logo designer, and paying for permits, licenses, and fees are generally considered to be one-time expenses. You can typically deduct one-time expenses for tax purposes, which can save you money on the amount of taxes you’ll owe. Make sure to keep track of your expenses and talk to your accountant when it’s time to  file your taxes .

Monthly expenses typically include things like salaries, rent, and utility bills. You’ll want to count at least one year of monthly expenses, but counting five years is ideal.

Add up your one-time and monthly expenses to get a good picture of how much capital you’ll need and when you’ll need it.

Use your startup cost calculations to get startup funding

It’s a good idea to create a formal report of your expected startup costs.

You want it in a format that’s clear and easy to understand. Investors and lenders compare expected costs to projected revenue and determine the potential for your business to profit.

See what it will cost to start your business

Download this fillable PDF spreadsheet to calculate your small business startup costs.

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Labor Costs: 7 Effective Tips While Rebuilding Your Business

By Shelbie Watts

Rebuilding after forced closures due to the coronavirus pandemic can be a scary experience for small business owners. No one is sure what consumer behavior will look like in the near future. And while it’s exciting to be able to bring your staff back to work, you’ll need to understand managing labor costs responsibly to avoid any future layoffs.

It’s no secret that annual payroll costs are the majority of a business owner’s expenses—and costs are only rising. Still, your long-term labor cost reduction strategy doesn’t have to include letting anyone go.

Here are a few tips on how to manage total labor costs and boost employee productivity at the same time.

Get more control of your labor costs with the free Homebase app.

What are Labor Costs?

When you break it down, labor cost encompasses the total amount paid out for employee salaries, perks, and payroll-related taxes. These can be categorized as either direct or indirect costs. The first deals with salaries for employees hands-on in creating a product, like those on an assembly line. The latter deals with salaries for roles like maintenance or security staff.

Key Points to Keep in Mind About Labor Costs

• Labor cost divides into direct and indirect categories.
• The salary of those involved in making a product falls under direct costs.
• Support roles, such as maintenance, fall under indirect costs.
• Not correctly allocating labor costs can skew the actual cost and affect profit margins.

Going Deeper into the Concept of Labor Costs

Calculating the right selling price for a product or service involves considering labor costs along with other expenses. Missing any cost component can cut into the profits. So, businesses aiming to stay ahead often look for ways to curtail labor costs, especially during downturns. In specific sectors, like hospitality, customers might indirectly bear some labor costs through mechanisms such as tipping.

Drawing a Line Between Direct and Indirect Costs

Let’s look at a firm named ABC Furniture that’s set to launch dining room chairs. Here, the salaries of those managing machinery for the chair components would be direct labor costs. In contrast, the salaries for roles such as security would be indirect since they’re not tied to distinct manufacturing processes.

Fixed and Variable Labor Costs

Labor costs might be static or dynamic. The dynamic ones shift as the production level changes, giving businesses flexibility. However, static costs don’t waver, irrespective of production quantities. These typically manifest in long-term commitments like maintenance contracts.

The Pitfalls of Misallocation of Labor Costs

Attributing indirect labor costs correctly to specific products or services isn’t straightforward. For instance, if ABC Auto Parts misassigns labor costs between products, such as parts and services, it can mislead the final price. Mistakes in allocation can mean selling prices don’t reflect true costs, leading to profit dips.

Labor Cost vs. Living Costs

It’s essential to differentiate between labor costs and living costs. Living cost refers to the money needed to maintain a certain lifestyle in a location, factoring in housing, food, commute, and more. Sometimes, in areas with high demand, such as New York City, living costs might surpass labor costs.

7 Tips to Manage Labor Costs

We have curated the 7 best tips from experts on finance and labor cost management. These experts include Homebase’s VP of Sales and Service and CFO. You’ll also hear the perspective of a small business owner just like you, to offer you first-hand insights when it comes to rebuilding a business.

Know Your True Labor Costs

In order to determine how to manage labor costs, paint an accurate picture of what you’re spending on each employee. The true labor cost includes more than just their hourly wages. This is called your labor burden rate.

Extra payments like payroll taxes and benefits can add 12-20% on top of the gross wages. Be sure to calculate the true amount, it’s important!

To calculate the burden rate of an employee, add up the annual salary or total wages paid in a year, any bonuses or overtime payments, payroll taxes, and benefits like healthcare, paid vacation time, and 401(k). Understanding your burden rate can help you make more informed labor cost decisions.

Homebase VP of Sales and Service Luke Wilson highlighted how important it is to know in real-time exactly what you’re spending on each employee so you can make changes to avoid spending extra money.

“I think a lot of people do not know when their employees are into overtime,” Wilson said. “A lot of people find out they had five employees in overtime that week when they’re doing payroll, not in real-time.”

Understand the Labor Cost of New Operations

It’s no secret the world has drastically changed due to the coronavirus pandemic—and businesses all over the world are reflecting that change by pivoting or trying new operation tactics and implementing more stringent health and safety strategies .

With new operations and strategies come updated labor costs and staffing level needs for your business. Pay close attention to how much you could potentially be paying for your new changes and determine if the project profit is worth the increase in cost.

Optimize Scheduling

Speaking of overtime , a great way to eliminate it is to get a clear employee scheduling process in place. Not only will you have a more regular look at the work weeks and number of hours ahead, but your employees will also know ahead of time what their shifts will be and can plan accordingly, and you’ll be able to avoid any surprise overtime shifts.

Even better, utilize software like Homebase to do the hard work for you. With Homebase, you can create work schedules in minutes with our easy templates, and you’ll be forecasting your labor costs easily.

The Homebase app takes overtime avoidance a step further by automatically calculating overtime hours for you and alerting you when an employee is about to hit them so you can save money on overtime costs. This way, you can forecast labor costs right there from the app.

Enforce Time Clock Compliance

It’s more important than ever to ensure the hours you schedule for an employee match up with the schedule you created in order to prevent early clock-ins or overtime payments. If overtime is needed, but it’s unplanned, make sure that the extra time worked requires manager approval or override.

The Homebase free time clock app can help automate this as well. The feature helps you save money by preventing employees from clocking in early and automatically clocking them out when they forget. This means that every week the hours you scheduled equal the hours worked by your employees, and you won’t encounter any expensive surprises.

Reduce Voluntary Benefits

No one wants to be the employer who takes away provided benefits and perks, but if reducing small amounts here and there can increase your team’s job security and leave the door open to hire new employees—like the extra staff needed for new operations—the sacrifice may be worth it.

Homebase CFO Jason Liu said it’s important to rethink what you’re spending on each employee when determining how to manage the cost of labor, at least for right now.

“Revisit your budget in the new world,” Liu said. “Be conservative, there’s a lot of uncertainty.”

Part of the labor burden for each employee includes your benefit package. Take a look at what you’re offering and determine if you can cut back anywhere.

Reducing your spend in the bucket of benefits doesn’t mean you have to stop offering them. Make adjustments where you can, such as increasing the employee’s deductible slightly or converting pension plans to profit-sharing plans.

Whatever you change, change it across your entire team—and make sure everyone is aware. Trying to hide the alterations from your employees will lower morale, but transparency will keep everyone informed and prevent employee turnover.

“After you make changes, be transparent to your employees about what you’re doing and why,” Liu said.

Know Your Customer Tolerance

Your consumer base most likely has an expectation on how long they’re willing to wait to be greeted or served. Know this expectation, and work around it.

This awareness could make you realize that you may not need to schedule as many people on one shift. You may also realize your employees can get other work completed instead of spending their energy on customers.

Wilson said knowing that customer expectation and tolerance means your team can increase productivity while satisfying consumer needs.

“What’s the tolerance the customer will give you?” Wilson said. “If you look at the automobile business, if someone walks into a showroom and doesn’t get greeted, they’ll turn around and walk out because they feel snubbed. It’s because everyone is with someone else.

“But instead of having 20 salespeople, you have 10 salespeople and maybe two greeters. Or an active receptionist who focuses solely on the incoming customers for the front showroom. Then he or she can say hi, get them some coffee, let them know it’s going to take about 15 to 20 minutes to speak to a salesperson. One thing I’ve learned is if they know what to expect, they’ll be patient.”

Consider a Commission-Based Pay Structure

One strategy on how to control labor costs is to tie employee wages into revenue they brought into the business. Your employees may prefer a commission rate and lower base pay if the end result is more money.

Marnie Gaston, owner of Gaston Wrecker Service & Storage , pays her tow truck drivers 25% of every service ticket they complete. She said her employees are more productive and appreciate the opportunity to make essentially as much money as they want.

“It’s easier for me to just pay my drivers 25% of the total ticket,” Gaston said. “Plus without a base salary, they work harder and take pride in the fact that they are truly earning every commission they make.”

———————————————————————————————————————-

The bottom line, is to be transparent with your employees about any changes you decide to make to your business. Whether you’re switching to commission, reducing employee benefits, or getting creative with staffing levels, lay it out in detail.

Tell them how you came to the decision and why you think it’s important. Doing so will instill confidence in your team that you are looking out for the best interests of everyone and keep employee retention high.

Remember:  This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.

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9 Steps for Accurate Labor Budgeting & Forecasting

The elastic nature of your workforce makes it necessary to have accurate and timely labor cost visibility.  

You’ve been forecasting your labor needs according to your anticipated volume and customer requirements. But now you are blowing past budget and aren’t sure why. This article helps you get to the root cause. What causes your teams to exceed their labor budget, and was your allocation correct to begin with? 

Let’s start with knowing exactly what influences your labor cost. Accurate allocation of labor spend across product types, customers, and processes, enable your team to plan for labor with confidence, and avoid surprises. 

The purpose of labor management systems, warehouse management systems, and other such tools is to reduce costs and improve productivity over time. But if you’re struggling with labor cost budget overruns, it’s probably time to go beyond productivity metrics and gain full transparency into your labor costs, and what influences your labor costs. In order to get your labor spend on track, you need to identify the underlying causes of the problem before you can fix them. You can start by asking these questions:

• Is your product volume higher than you predicted and budgeted for?
• Did you under-budget your overtime and wages?
• Did you use more overtime than you planned for?
• Could increased waste have been the cause? 
• Are you running an excess of Missing Time?
• Is your productivity running below standard? 
• Are you efficiently utilizing your onsite equipment?
• Have you communicated labor spend targets to your managers?
• Does your labor budget reflect changing business priorities, or is it “set it and forget it”?

Any and all of these questions could lead you to the source of your surprise budget overruns. They will expose whether or not the team is operating efficiently and whether or not your labor costs are realistically matching your volume and workflow. But you’ll need data to answer them. 

Drilling Down For Answers

Each of these questions may look straightforward on the surface, but more specific answers can be found by digging deeper into the data.

Let us put forward an example case: Company A has noticed that it’s running over budget, and takes a look at the data available. They’ve spent $2.5 million more than their allocated budget—a 23% overage. That looks bad, so they decide to investigate. The data reveals a 20% increase in volume across their facilities—which suggests that their costs are only 3% over what they should be with respect to the increased volume. So where does that remaining 3% come from? There are many possible answers, and the best way to find them is to again refer to the original list of questions and break it down by facility.

What is your overtime % across your facilities? What is your ELS% (productivity %), and how much could that be costing you? How much missing time do you have? These questions can guide you toward cost savings, while also helping you identify whether or not your budgeting issues are because of inefficiency, poor management, or merely changes in volume and customer requirements. 

Automating Labor Budgeting & Forecasting

Our Operations Financial Management (OpsFM) solution is specifically designed to give you cost and performance visibility into your various processes and facilities, with the goal of driving out waste and running your operations network with full financial visibility. Easy Metrics’ OpsFM solution integrates your operations data, such as existing LMS, WMS, and timeclock systems to expose cost to serve so you can gain visibility into everything that influences your labor costs. With this information in hand, you can dig down into the data to answer each and every one of those questions, identify the source of the cost overrun problem, and begin planning the best course of action.

Our budget dashboard allows you to look at your budget, ELS%, Volume-Adjusted budget, Overtime %, and other critical metrics from a company-wide perspective. If you want to dig deeper, you can view the variances in budget by facility, and select any locations you’d like to examine individually. Long-term tracking and measurement of trends and relationships (like the relationships between budget and incoming volume) are also readily available. Easy Metrics gives you the tools you need to locate the discrepancy, identify the problem, and determine a solution so you can have a better and more accurate labor budget that your team can align with.  

What About 3PL Profit Centers?

If you are a company that treats your distribution centers as profit centers, like a 3PL that charges the customer for the work performed, a purpose built tool for labor budgeting and forecasting is even more useful. Easy Metrics has a Profit dashboard that integrates with the Budget dashboard to give you an even more comprehensive overview of your operation. These tools are able to grant you unparalleled cost visibility into your operations, giving you everything you need to budget accurately and drive financial accountability across your team. 

Setting and keeping within established labor budgets can be difficult, especially in today’s upended and dynamic supply chain environment. Both of those things require a solid, data-driven foundation to be effective, and we want to help you acquire that foundation. Easy Metrics’ Budget dashboard helps you eliminate errors and reduce your reliance on spreadsheets, stop getting surprised by budget overruns, and drive stakeholder buy-in and financial accountability. 

If you’re interested in gaining visibility into what influences your facilities’ labor costs and align your labor spend to business priorities, contact us . We’ll show you how easy it is to get started.

Ready to have cost to serve analytics in your operations? Sign up for a demo of Easy Metrics today.

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14 Business Startup Costs Business Owners Need to Know

Many or all of the products featured here are from our partners who compensate us. This influences which products we write about and where and how the product appears on a page. However, this does not influence our evaluations. Our opinions are our own. Here is a list of our partners and here's how we make money .

Deciding to start a business is exciting, but can also be daunting if you're a new entrepreneur. Calculating business startup costs, worrying about long-term profitability, securing startup funding — it can all be pretty stressful.

The question of costs is critical because the initial investment can be significant. A Kauffman Foundations study shows the average cost to be around $30,000, and costs tend to increase each year.

Fortunately, certain types of businesses, such as micro-businesses and home-based companies, have lower financial entry barriers. Here, we’ve put together a list of 14 different types of business startup costs you’ll need to consider when launching your company.

ZenBusiness

How to calculate the cost of starting a business

Drafting a business plan is the best way to estimate your business startup costs. Within your plan, the financial projections section should estimate your revenue, profit, and expenses for the next three to five years.

There are other resources to estimate your finances as well, such as the SBA’s startup costs worksheet . Templates will help you estimate your initial investment costs, so you know how much capital you should request when you seek startup funding.

Keep in mind that many of the business startup costs we list below are recurring. You'll need to cover these costs over a monthly, quarterly, or annual basis — think rent, office supplies, and payroll. Other expenses, like the incorporation fee or office furniture, are one-time costs.

When calculating your business startup costs, a good rule of thumb is to be able to cover six months’ worth of expenses upfront. So don’t count on your business’s revenue to start easing your costs until at least after that early period is over. You’ll want a cushion while you get your feet under you and work on attracting business.

>> MORE: Best business budgeting tools

14 business startup costs to plan for

Although this is a typical list of business startup costs, your actual startup expenses depend entirely upon your specific business and industry.

Here are some typical business startup costs to plan for:

1. Equipment: $10,000 to $125,000

Almost every business will need to finance equipment immediately. Equipment costs for startups can range anywhere from $10,000 to $125,000, depending on the industry and size of the company.

For example, if you’re starting your own moving or shipping company, you’ll need to finance a truck. If you’re opening a restaurant, you’ll need commercial-grade ovens, stoves, dishware, and cooking utensils. If you own a hair salon, you’ll need styling chairs. And nearly any business will require computers.

Of course, these costs range according to your industry and the size of your business. Hiring employees will incur additional costs, as you may need to secure individual equipment, as well.

How much do you need?

with Fundera by NerdWallet

We’ll start with a brief questionnaire to better understand the unique needs of your business.

Once we uncover your personalized matches, our team will consult you on the process moving forward.

2. Incorporation fees: Under $300

One of your first to-dos when setting up a business is to choose a business entity, which has tax, legal, and financial implications.

If you decide to incorporate your business or form a limited liability company, you’ll need to file articles of incorporation or articles of organization, respectively, with your state. The filing fee can range from $50 to as high as $725 depending on the state. However, the fee is under $300 in the majority of states.

Even if you’re not incorporating, you’ll probably need to apply for federal or state licensing or permits. The types of documentation you'll need will vary based on your industry and location. For example, businesses within the agriculture or aviation sectors require federal licensing. Service-based sectors may need to have trade-specific licenses. And retail companies will likely need sales tax licenses or permits.

3. Office space: $100 to $1,000 per employee per month

Paying for an office or retail space will be a sizeable portion of your fixed costs, whether you rent or buy. You might spend between $100 per employee per month up to $1,000 per employee per month — again, it will depend on the type of space you're using.

You can mitigate these costs if you work from home in the beginning, or look into coworking spaces — both ideal for smaller businesses. And if you own a service-based business, you can travel directly to clients to further decrease overhead costs.

4. Inventory: 17% to 25% of your total budget

If you’re in the retail, wholesale, manufacturing, or distribution sector, you'll likely need to secure inventory to sell, as soon as you possibly can.

Knowing how much inventory to carry can be tricky: If you have too much inventory, you risk spoilage or damage. If you have too little, you risk losing customers who won't wait for items on backorder. This is especially true for seasonal businesses where inventory can vary drastically year-round.

You should allocate between 17% to 25% of your budget to inventory, depending on your industry. When you’re first starting out, consider securing more inventory. You'll want to attract customers and generate as much revenue as you can in your company's early stages.

5. Marketing: Below 10% of your total budget (even 0%)

Marketing materials might include physical materials, like signs, banners, and business cards. You might also consider paid ads, as well as more creative options, like videos and giveaways, that might require you to hire a consultant or a video producer.

Courtney Barbee, COO at The Bookkeeper, recommends keeping overall marketing costs to a minimum. Specifically, strive to keep your ad materials under 10% of your budget.

The good news? You can do the bulk of your small business marketing, for free. Thanks to social media and other online marketing strategies, advertising costs are often much lower for small businesses just starting now than they would have been 20 years ago.

6. Website: Around $40 per month

When building your business website, you'll want it to look professional, be easy to navigate, and display information about your services, products, hours, and contact information.

Fortunately, services like Wix, Squarespace, and Weebly, make creating a website easy and cost-effective. These content management systems are sometimes free, but premium plans will come at a monthly or yearly subscription cost:

Wix : $13 to $39 per month for a premium plan.

Squarespace : $12 to $18 per month billed annually, or $26 billed month to month.

Weebly : $5 to $25 per month.

Wix and Weebly also offer basic, free website builders. If you’re relatively tech-savvy, it’s easy to build a website through one of these services, no coding background required. But if you’re not very familiar with computers, you may want to hire someone to build the website — which, of course, is an additional cost (although it might become a worthwhile investment).

7. Office furniture and supplies: 10% of your total budget

Office furniture and supplies add up fast. If you’re operating in a traditional nine-to-five office environment, then every employee will need a desk, a chair, a computer, and a phone. Add in break room appliances, small office supplies, and computer programs, like your accounting software, and you’ll reach a hefty sum.

Again, that sum varies depending on the tools your business needs to operate, and the number of employees you need to outfit. Nate Masterson, the marketing manager at Maple Holistics, estimates that the total cost for office furniture and supplies would be around $5,000. In all, though, Masterson recommends keeping your furniture and supply costs to approximately 10% of your budget.

8. Utilities: Around $2 per square foot of office space

In addition to the fixed costs of rent and a down payment, you’ll be responsible for paying the electric, gas, water, internet, and phone bills for your office space. According to Iota Communications, the average cost of utilities for commercial buildings is $2.10 per square foot.

If you intend to install HVAC units, that will incur an additional cost — usually a couple of thousand dollars, not including installation fees and upkeep.

9. Payroll: 25% to 50% of your total budget

You need to pay your employees, even in the early stages, where you’re not bringing in much revenue. Remember, payroll includes all of the following:

Commissions.

Overtime pay.

Paid time off.

Of course, payroll costs will vary across startups. Typically, an employee will cost 1.25x to 1.4x their salary. For example, an employee on a $40,000 salary will actually cost you around $54,000 after factoring in various payroll tax costs and insurance.

A conservative payroll budget could work if you’re a sole proprietor, or if you’re running a small enterprise and use mostly 1099 contractors — and either is a pretty likely scenario for most startups.

10. Professional consultants: Between $1,000 and $5,000 per year

It’s tempting to take a DIY approach for all your business operations. After all, who knows your business best? But working with experts and professionals can be worth the investment.

For example, certified public accountants can explain the different legal structures, help you choose an employee benefit program, and ensure you're fulfilling your responsibilities as an employer. When tax season rolls around, they’ll prepare your tax returns and help you save on your taxes.

You don't need to hire a full-time accountant either. But it’s often a good idea to consult with your accountant on a monthly, quarterly, or annual basis to review your financial statements, and for general financial guidance and advice. Consulting with an attorney regularly can also save you from major legal mistakes like failing to trademark your logo or developing relationships with vendors without a contract in place.

Every CPA and lawyer charges different hourly rates. Rates and additional fees vary depending on the number and level of difficulty involved in the tasks you need outsourced, the time it takes to complete your projects, and your consultant’s tenure. However, you can mitigate these costs by taking on some basic tasks yourself, only outsourcing the most complicated projects. There are even some options to get free business legal advice.

And with the help of good business accounting software, you can handle basic bookkeeping, like processing and managing payroll, creating and tracking invoices, and managing your business bank account.

According to SCORE , all told, the majority of small business owners spend between $1,000 and $5,000 per year on administration tasks, including accounting and legal fees. But as a startup — and by taking advantage of those cost-cutting tactics we mentioned — you’ll probably err on the lower end of that spectrum.

11. Insurance: Average of $1,200 per year

Your business needs the same protections you provide to your health, home, and car. There are many different kinds of business insurance , including protection from customers that file a lawsuit against you and disaster insurance for potential fires that can shut down your restaurant for weeks.

The type of insurance your startup needs is entirely dependent on your business, industry, number of employees, and other risk factors. For instance, a sole proprietor running an online business has far fewer insurance requirements than a construction company with several employees.

Here are a few essential forms of insurance you should look into to protect yourself, and policy costs vary according to several different factors:

General liability insurance : About $400 to $800 per year. Your industry’s risk will be the most significant factor influencing the cost of your policy.

Commercial property insurance: Anywhere from $300 to $2,500+, depending on the value of the property and its assets, and a risk factor dependent upon the nature of the business and the location of the property.

Workers compensation insurance : Approximately $0.75 to $2.74 per $100 of payroll, depending on the business’s size, location, payroll, and risk.

Errors and omissions insurance: Approximately $2,000 to $5,000 per year, depending on your business’s size, industry, location, revenue, legal history, and the quality of your contracts and employee training procedures.

12. Taxes: Variable, but 21% corporate tax rate

When planning your budget, determining the exact amount to allocate toward business taxes can be confusing. It depends on your revenue (which is difficult to predict), your deductible expenses, and your business entity.

Under current federal law, corporations pay a flat 21% corporate income tax. For pass-through entities, business income and losses pass through to the owners' personal tax returns. Pass-through entities can claim a 20% deduction on income before paying their business taxes.

But know that you can often save money and time by working with a CPA. A skilled CPA will determine what you can deduct so that you pay as little as possible.

13. Travel: Variable

Not every new entrepreneur needs to factor travel into their business startup costs. But if you have a consulting business or you visit your customers directly, you will be traveling a lot. You'll need to factor in the price of transportation, food, and lodging — multiply these costs if you have multiple employees traveling. Be mindful of how quickly those costs add up.

Try to keep total travel costs to an absolute minimum so that you can allocate your revenue toward bigger expenses, like payroll and rent. And to make some returns on all that time on the road or in the air, consider using a travel business credit card, which can earn you points and miles for every dollar you spend. If you do have to travel frequently, keep the nonessentials like business class tickets to a minimum.

14. Shipping: Variable

Service-based businesses can probably stop reading here. But if you’re in retail, you might be shipping products to customers. If so, you’ll need to factor shipping into your startup costs, including packing materials and postage. Depending on what you’re sending, these costs can reach into the thousands of dollars.

Services like Stamps.com can ease the burden of shipping costs on small business owners. With this service, you can print postage without having to buy a costly postage meter. If possible, you can secure free or low-cost shipping boxes from your shipping service of choice.

How to save on startup costs

The costs of starting a business can certainly add up, with many expenses being non-negotiable. Do your research before you splurge on high-ticket purchases, and recognize that there are ways to take care of some of these startup costs on the cheap.

For example, using software like QuickBooks can save on the costs of hiring a professional bookkeeper. Working from home or using a coworking space is a cost-effective alternative to leasing office space. And leveraging social media can mitigate your marketing costs.

Some costs are worth the investment. Don’t buy poor-quality equipment just because it’s cheaper — you’ll lose time and money making repairs and eventually need to purchase new equipment. Hire a legal or accounting expert if you’re confused. And make sure your website and advertising campaigns are professional-looking and effective.

Secure funding

If you've calculated your business startup costs and now feel overwhelmed, know that there are plenty of resources to help you find startup financing.

Your initial funding will likely come from a combination of debt and equity financing. But keep in mind that debt financing options — small-business loans — are relatively limited for brand-new businesses. Most lenders only feel comfortable offering loans to established companies with hard evidence of profitability, as well as healthy credit, which most startups simply don’t have yet.

Some lenders work with startup business owners, so don’t completely rule it out if you think it’s your best option. Check out more information on how to get a loan to start a business if you think debt financing is the right move for you.

» MORE: What is a business loan?

Get a business credit card

Once you’ve established a legal entity for your business, we recommend applying for a business credit card.

The application is simple, and a business credit card is usually easier to qualify for than a traditional business loan. Also, you typically gain access to a higher credit limit than your personal card. More importantly, a business credit of card keeps your personal and business finances separate — essential if you wish to maintain your personal liability protections after forming an LLC or corporation.

» MORE: What is a business credit card?

Just make sure you’re not maxing out your credit card or charging more than you can repay. Both can harm your credit score, which might hurt your chances of securing a small business loan down the line.

Start Your Dream Business

Frequently asked questions

1. what is the average cost to start a small business.

The cost of starting a small business depends on the type and size of the business you’re opening and your industry. For example, opening a McDonald’s franchise can cost you $1 million, while starting a social media consulting company may cost less than $10,000. The average cost will vary on a case-by-case basis.

2. How do you calculate startup costs?

The most straightforward method for calculating your startup costs is to use a budget template. Your budget will break down your startup costs and recurring expenses — rent, office supplies, payroll, and more.

It’s prudent to cover six months’ worth of expenses minimum upfront; this financial cushion will support you in your business’s early stages when your profit margins might be slim.

3. Are business startup costs tax-deductible?

While the IRS does not recognize startup costs as capital expenditures, they do state that you can deduct $5,000 of business startup and $5,000 of organizational costs paid or incurred after October 22, 2004, but only if your total startup costs are $50,000 or less.

You can review IRS Publication 535 or consult a business accountant for additional information.

4. What is considered a startup cost?

A startup cost is any expense incurred when starting a new business. Startup costs will include equipment, incorporation fees, insurance, taxes, and payroll.

Although startup costs will vary by your business type and industry — an expense for one company may not apply to another. For example, a brick-and-mortar business will need to pay to rent a separate business location, unlike a home-based online consulting company.

This article originally appeared on JustBusiness, a subsidiary of NerdWallet.

On a similar note...

How To Calculate Labor Costs: Free Excel Labor Cost Template

Do you waste hours every week trying to calculate employee labor costs? Are you trying to figure out how to decrease overtime? If so, you need a labor cost calculator.

However, you might not have the time or Excel know-how to build your own. Fortunately, you can take the hassle out of creating a labor cost calculator by using a template.

If you’re looking for a free labor cost template, Excel spreadsheet templates from When I Work are a great resource. We help take the hassle out of crunching numbers with our free labor cost calculator Excel template.

Here’s everything you need to know about our employee cost calculator Excel template, including how to use it and what perks it offers your business.

Save time and skip the spreadsheet. Try When I Work free for 14 days and get automatic labor cost breakdowns and reports.

Calculate labor costs efficiently with a free labor cost calculator (Excel)

First off, you probably want to know what an employee cost calculator Excel spreadsheet even is. Basically, it’s an Excel spreadsheet that’s preconfigured with formulas to calculate costs like the following:

• Gross labor hours
• Labor hour rate

If it’s a labor cost-related expense, you can track it in our free labor cost template Excel spreadsheet. 

The best part is that it’s reusable. Like any Excel template, you can save it to your device and use it time and again. 

Whether you need to create five, 10, or even 100 labor cost spreadsheets, you can do it with our free template. 

Even if you’re an Excel guru, adding in custom formulas can take forever. With our template, you can spend that time focused on something else. We’ve done all the work for you so you can get a functional template in seconds, not hours.

How to use the labor cost calculator

When I Work is all about making life easy for small business owners. Every interaction with When I Work is a breeze, including using our labor cost calculator Excel template.

You can start using our template in three easy steps:

1. Download the labor cost spreadsheet

The first step is to download our employee cost calculator Excel template. As promised, it’s totally free. 

You won’t be asked for any credit card information when downloading the template. All you have to provide is:

• Your email address
• The industry you’re in
• The number of people you manage (10–20, 50–100, etc.)

Don’t worry—you won’t get bombarded with emails, either. We just want to keep you in the loop about other When I Work tools designed to make your life easier.

For instance, we also offer a free scheduling template and other great no-cost tools. Our full lineup of tools can transform how you track costs and manage schedules.

When you’re ready to take your scheduling and cost-tracking skills to the next level, you can try the When I Work platform for free. Our 14-day trial gives you a chance to take our app for a test drive. You’ll see why it’s the top option for small businesses. 

2. Input your data

After downloading our labor cost calculator, simply put your data into the appropriate calculation boxes. Every box is clearly labeled with bold headers and subheaders. If a particular box doesn’t apply to your business, skip it.

Some of the headers in our template include:

• Calculate Gross Pay
• Calculate Net Pay
• Calculate Other Annual Costs

And here are some of the specific input sections:

• Gross hours per week
• Gross hours per year
• Absent days per year
• Hours not worked per year
• Net hours worked 

Our template is designed to help you take a closer look at your labor costs. You can use it to identify sources of waste and maximize your savings. 

3. Document your results

After putting your data into the appropriate fields, the template will run the calculations for you. For instance, once you fill in the gross hours per week and pay rate, our template will calculate the person’s gross pay and gross hours per year.

To help preserve the function of the template, we’ve protected the cells with calculations. Yellow fields are your input boxes, and gray fields are the results of each calculation.

At a glance, you can learn everything you need about labor costs. Talk about easy!

But the free labor cost calculator Excel spreadsheet is just one offering in the When I Work toolbox. Check out our free time card calculator and save yourself even more time each week.

Benefits of using a labor cost spreadsheet

Our labor cost spreadsheet provides a ton of benefits for your business. Here are a few of the highlights. 

You can keep track of labor costs more efficiently

Losing sight of your labor costs can undermine your long-term growth. But you don’t have to let it happen. Just download our free spreadsheet and make tracking labor expenses a breeze.

You don’t have to be an Excel master to use our spreadsheet. Just download the template, name your custom file, and start inputting data. Everything is color-coded, and the calculation boxes are protected. This makes it impossible to accidentally mess up the pre-built formulas.

If you need to go back and track past costs, you can do so in seconds. This well-organized spreadsheet makes it effortless to find the exact information you’re looking for.

Labor cost calculators save you time

If you’ve been tracking labor costs manually, you know it can be time-consuming. This is especially true if you have to switch back and forth between multiple apps and a calculator. Why not save yourself a whole lot of time (and frustration) with our template?

Getting started takes just a few minutes, and you’ll save countless hours over the course of the year. Download our template, name your file, and start crunching numbers.

All you have to figure out is what to do with all that extra time.

Spreadsheets can help you determine how to reduce labor costs

Our spreadsheets are designed to plainly break down your various labor costs. It includes important fields like:

• Absent days
• Hours not worked

Since you track these costs per employee, you can identify trends that are driving up your costs. For instance, if one employee is working lots of overtime or consuming too many supplies, you can explore ways to reduce these expenses. 

There’s an easier, faster way to track employee labor costs

Instead of bouncing around from spreadsheet to spreadsheet, labor cost tracker to schedule, back and forth again, keep track of it all in one place. When you use When I Work, you can see your labor costs add up as you build the schedule, and get overtime alerts when someone is scheduled to work over their max hours. That way, you’re not scrambling to edit a finished schedule to decrease labor costs, but you can build the schedule from scratch with your labor budget in mind, saving you time and money every week.

Keep track of labor costs with When I Work

A free labor cost calculator Excel template can make tracking your labor costs so much easier. But if you want to maximize your cost and time savings, you should check out the full lineup of When I Work solutions.

The When I Work app is an all-in-one time clock, messaging, scheduling, and labor cost-tracking solution. You can check attendance, assess costs, and gain real-time insights into your business at a glance. You can even run reports to turn your labor data into easy-to-read charts and graphs.

But don’t just take our word for it. Sign up for a demo or take advantage of our two-week free trial and experience the magic for yourself.

Start your free 14-day trial of When I Work! Click here to start scheduling your employees today.

Labor cost spreadsheet FAQs

Q: what is a labor cost calculator.

A: A labor cost calculator is a spreadsheet tool that helps you calculate and track your labor costs. It allows you to input various factors, such as employee wages, hours worked, benefits, and overhead expenses, to determine the total labor cost for a specific period.

Q: How can a labor cost calculator Excel template benefit my business?

A: You’ll get accurate calculations of labor expenses, help in budgeting and forecasting, better cost management, easier comparison of labor costs across projects or periods, and aid in identifying areas for improvement.

Q: Can I use a labor cost calculator for different industries?

A: Our labor cost calculator can be used for different industries. While the specific inputs and factors may vary, you can customize the structure and functionality to suit your industry’s labor cost calculation needs.

Q: How do I use a labor cost calculator Excel template?

A: Enter the required inputs, such as employee wages, hours worked, benefits, and other relevant factors. The template will then automatically calculate the labor costs based on the provided data and the predefined formulas within the spreadsheet.

Q: Can I customize a labor cost calculator Excel template to fit my needs?

A: Most labor cost calculator templates are customizable. You can modify the template to include additional fields, change formulas, adjust formatting, and tailor it to match your specific business requirements and industry standards.

Q: Are labor cost calculator templates easy to use for someone with limited Excel knowledge?

A: Labor cost calculator Excel templates can vary in complexity. However, those that When I Work offers are designed to be user-friendly, even for newcomers to Excel. 

Q: Can a labor cost calculator help me determine my labor expenses accurately?

A: One of these tools can help you accurately project your labor expenses by considering various factors, such as wages, hours worked, overtime, benefits, and other relevant costs. It automates the calculations, reducing the risk of manual errors and providing a reliable estimate of labor costs.

Q: How does an employee cost calculator help in budgeting and forecasting?

A: A labor cost calculator aids in budgeting and forecasting by offering a clear overview of your labor expenses. It allows you to input projected labor costs, compare them with actual costs, and analyze trends over time. This helps you make more accurate budget forecasts and adjust your financial plans accordingly.

Q: Is there an automated way to track labor costs?

A: Yes! You can use When I Work to track your labor costs as you build the schedule. You’ll be able to see what each shift costs and you’ll get an alert if you schedule someone for overtime, so you can make adjustments before the schedule ever goes out. When I Work automatically tracks your labor costs for you so you can save time and money and run your business more efficiently.

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Labor Cost Control: 19 Ways to Reduce Manpower and Labor Costs  

By   Jack

For most business owners, labor cost control is a top priority. If you’re looking to reduce labor costs, you’re not alone – the average business owner spends 50 to 60% of their budget on labor costs.

There are countless ways to reduce labor costs and manpower, and in this article I’ll be covering 19 ways you can do it in your business.

Analyzing each strategy can help you determine what measures work best for your business and budget.

What is Labor Cost Control?

Labor cost control is the process of measuring, monitoring, and managing labor costs to maximize efficiency. It’s a way for employers to identify areas where they can reduce direct labor costs without sacrificing quality or service. It also helps employers understand how their costs are changing over time and make decisions about how to allocate resources in order to maximize efficiency.

The process involves analyzing labor trends, understanding the impact of changes in labor regulations, managing overtime costs and business schedules, measuring worker productivity, and ensuring that wages are competitive with those of other employers. It also requires setting clear goals for labor efficiency and tracking performance against those goals.

Why Is it Important to Control the Cost of Labor?

Controlling labor costs is important for many reasons. It can help businesses remain competitive , reduce expenses, and improve customer service. It also helps employers attract and retain top talent by providing wages that are comparable to those of other employers in the industry.

By finding ways to reduce your labor costs you can ensure you’re operating efficiently while still providing a quality product or service. This allows them to remain profitable and continue to grow, which is essential for any business to be sustainable.

Benefits of Reducing Labor Costs

Implementing an effective system of labor cost control can create a wide range of benefits for your company. Here are just a handful:

• Financial savings by reducing overhead costs (i.e. employee pay, benefits, or taxes )
• Improve employee morale and engagement by providing fair pay and incentives
• Reduce employee turnover
• Increased productivity, efficiency, and customer service quality

To illustrate the tangible impact this can have, let’s assume your company currently has 15% profit margins.

Each 1% reduction in expenses you can create will increase your profits by 15X.

How Can Employers Control Labor Costs?

Before getting into the strategies, step one is to analyze your current labor expenses.

• How much money are you currently spending on labor?
• How do your company’s labor costs compare to other similar businesses in the industry?

Once you have a good understanding of your current costs and how they compare to others, you can start looking at strategies to reduce labor costs.

Cutting labor costs can be done through these 19 ways:

Cut Overtime

Make sure employees only work overtime when absolutely necessary.

Determine when overtime is beneficial and necessary, and monitor overtime hours to ensure that pay rates are not getting out out of control.

A few ideas:

• Offer incentives for each employee to complete tasks in regular working hours
• Think about more efficient ways to organize employee scheduling
• If possible, try to use part time employees or hourly workers instead of full-time workers who work more than 40 hours per week

Streamline and Automate Processes

Analyze current processes to identify areas where they could be improved or streamlined to increase efficiency and save money.

Evaluate your current operations to identify redundancies, unnecessary or outdated processes and areas of waste.

This freed up time can allow more capacity for high value activities (i.e. focusing on how to get future sales).

One tactical way to do this: make your team justify why they need each and every existing process. This exercise alone should likely eliminate 50%+ of time spent on current processes.

Automating certain tasks and using emerging technology can eliminate the need for manual labor. Consider using automated scheduling programs or online systems that streamline processes such as inventory management , software development, payroll processing, and customer service inquiries.

Invest in Hiring and Onboarding

Investing in the right people is essential.

Your recruitment and onboarding process should be designed to attract and retain talented individuals who can help you operate efficiently and achieve your goals.

Look for candidates who have skills and experience relevant to the job, and make sure you provide adequate training for new employees so they can be successful in their roles.

Adopt Flexible Working Practices

Consider offering flexible working practices that allow each employee to work remotely or set their own hours. This can help reduce overhead costs while also providing employees with the flexibility they need.

By offering flexible work practices, you could help reduce turnover and encourage staff to stay with your business for longer periods of time, reducing recruitment spend over the long run.

Track Performance to Reduce Labor Costs

Make sure to track employee performance data so you can identify areas where spend is increasing or productivity is lagging behind.

Are there ways to optimize employee scheduling or employee hours?

Can you improve forecasting and limit surprises and unforeseen costs?

This can help you adjust processes or personnel if necessary, to ensure your labor burden remains within budget.

Hiring Freeze: No More Hires, Outside Contractors, or Temps Without Your Consent

Implement a policy that requires all new hires and temporary workers to be approved by senior management before they can join the team. This will help minimize payroll creep and ensure only essential personnel are hired.

I recommend not creating forms for this – make your team ask you personally. This requires people to justify and make a strong case for any potential new hires.

Keep your staff lean and hire only when absolutely necessary (or else you’ll likely end up with unnecessary and redundant positions). If you can keep your business running smoothly without it.

Utilize Technology

Look for ways to use technology such as cloud computing, artificial intelligence or robotics to improve efficiency without sacrificing quality or customer service.

Can you reduce pay overages and spend less money by optimizing schedules?

Have advance notice around customer traffic support spikes and schedule changes?

Technology solutions such as automated scheduling software, time tracking, and online payroll can help employers reduce human error and labor burden.

Review Benefits

Evaluate the benefits package you offer employees to ensure it is competitive and cost-effective.

Are your hourly wages and benefits in line with your competitors and industry?

Aim to provide only what each employee values, nothing more. I’d recommend keeping a pulse on what your team wants the most when you craft your benefits packages and other perks (i.e. health insurance , pension plans, PTO).

Reduce or Eliminate Off-Site Events

Cancel or reduce off-site events such as company retreats, conventions and conferences. These events can be expensive and time consuming for both your team and the organization.

Most of your employees likely would prefer not to travel away from their families, so this is a win-win.

Invest in Training to Increase Productivity

Make sure your full time employees are working efficiently and effectively by providing them with the necessary resources, training and motivation to do their jobs well. This can help you create a smarter workforce and maximize output without having to hire additional staff.

Providing employees with additional training can improve their efficiency and boost productivity, reducing the need for extra staff.

Outsource Non-Essential Tasks

Outsourcing tasks such as IT support, bookkeeping or customer service is likely low-hanging fruit to reduce labor spend. Make sure to partner with reliable providers who can provide quality work in a timely manner.

Offer Incentives for Employees who Suggest Cost Saving Ideas

Encourage your employees to come up with creative ways to maximize efficiency. Offer rewards or incentives for ideas that are implemented, as this will help foster an environment of innovation and cost-savings.

Reduce Number of Managers

Reduce the number of managers in your organization. As a rule of thumb, you can likely get away with eliminating 2 out of every 3 existing managers.

If you think this is too much, test this at a smaller level (eliminate 10% of managers) and see if it results in any negative impact to the business. You could consider assigning multi-functional roles to existing staff, expanding span of control for your best managers, or even outsourcing managerial functions.

As the Harvard Business Review says, “management is the least efficient activity in your organization.”

No Automatic Bonuses or Raises

Provide a performance-based incentive system that rewards employees for meeting or exceeding goals. These performance bonuses should be tied to clearly defined expectations and outcomes, so employees are motivated to work efficiently.

Instead of giving bonuses or raises annually, I recommend moving towards periodic and unpredictable merit bonuses. This will remove entitlements and will be valued more by your staff. 

One way you can recognize hard work and effort is to give titles in lieu of bonuses.

Negotiate Rates

Wherever possible, negotiate rates with vendors or contractors who provide services that are essential for running your business.

This can help you improve cash flow while still getting the quality of service that you need.

Cross-Train Employees

Cross training staff can allow folks to perform multiple tasks and eliminate the need for specialized workers.

Can one employee take on the job of what many are currently doing?

This can help you save a significant amount of money and increase effectiveness by allowing employees to take on a variety of roles.

Annual Headcount Reductions

Aim to eliminate 10% of your lowest performing employees each year and replace them with higher-performing staff. Jack Welch was famous for doing this during his years running GE.

The truth is you likely have too many employees, and you should make cuts while focusing on retaining those with the most valuable skill set.

You can likely get rid of admins or managers that don’t contribute to profit or customer experience (or increase productivity). This can extend to functional areas such as accounting, IT, finance, and legal.

The goal is to upgrade your staff continuously and create a high-performance culture. 

Reduce Employee Turnover

I’ve written a detailed post on how to retain great people and increase employee morale .

A handful of takeaways:

• High performers are an astounding 800% more productive than other employees
• Pay your best folks 30% over market (those contributing to profits ) 
• A strong onboarding process is vital for retention
• The cost of retraining employees that are lost is extremely high

Monitor and Improve Labor Costs Regularly

Make sure to monitor costs regularly to ensure that you are staying within budget and making efficient use of your resources. Regularly review your data and make adjustments as needed.

A few recommendations:

• Establish efficiency goals within your business (i.e. reduce spend by 5% each year)
• Measure worker productivity and performance: utilize metrics to measure the productivity of individual workers so that you can identify areas where performance can be improved. 
• Track labor patterns over time, understand the impact of changes in labor regulations and assess how your company workforce is changing. 

These are just a few ideas to get you started around reducing manpower and improving efficiency to scale your business operations .

By carefully analyzing costs, setting clear goals, and tracking performance, businesses can develop a system that will help gain control of spend while providing top notch service and a quality product.

By thinking creatively and outside the box, you can come up with even more ways to save money while still maintaining a high level of productivity within your company.

Investor & Mentor

related posts:

SDE vs. EBITDA Adjustments: What Business Owners Should Know

Private sale vs. auction sale: what business owners should know, asset sale vs. share sale: what business owners should know, get in touch.

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How Much Does it Cost to Start a Business?

8 min. read

Updated April 25, 2024

What will it cost to start your business? This is a key question for anyone thinking about starting out on their own. You’ll want to spend some time figuring this out so you know how much money you need to raise and whether you can afford to get your business off the ground.

Most importantly, you’ll want to figure out how much cash you’re going to need in the bank to keep your business afloat as you grow your sales during the early days of your business. 

Typical startup costs can vary depending on whether you’re operating a  brick-and-mortar store, online store, or service operation . However, a common theme is that launching a successful business requires preparation.

And while you may not know exactly what those expenses will be, you can and should begin researching and estimating what it will cost to start your business.

• How to determine your startup costs

Like when developing your  business plan , or  forecasting  your initial sales, it’s a mixture of  market research ,  testing , and informed guessing. Looking at your competitors is a good starting point. Once you feel your initial estimates are in the ballpark, you can start to get more specific by making these three simple lists.

1. Startup expenses

These are expenses that happen before you launch and start bringing in any revenue. Here are some examples:

• Permits and Licenses: Every business needs a license to operate, just like a driver needs one to drive. Costs vary depending on industry and location.
• Legal Fees: Getting your business structure set up (sole proprietorship, LLC, etc.) might involve consulting a lawyer and at least will involve the basic business formation fees.
• Insurance: Accidents happen, and insurance protects your business from unforeseen bumps.
• Marketing and Branding: The ways to spread the word about your product or service. They could involve creating a website, creating business cards, or promoting social media.
• Office Supplies : Pens, paperclips, that all-important stapler – the essentials to keep your business humming.
• Rent/Lease: If you need to rent space for your business before you start selling, include those expenses in your list as well.

2. Startup assets

Next, calculate the total you need to spend on assets to get your business off the ground. Assets are larger purchases that have long-term value. They’re typically significant items that you could resell later if you needed or wanted to.

Here are a few examples:

• Equipment:  Think ovens for a bakery, cameras for a photography business, or computers for a tech startup.
• Inventory:  If you’re selling products, you’ll need to stock up before opening your doors (or your online store).
• Furniture and Decorations:  Desks, chairs, that comfy couch in the waiting room – creating a functional and inviting workspace might involve some upfront investment.
• Vehicles: If your business requires a vehicle to deliver your product or service, be sure to account for that purchase here.

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Why separate assets and expenses?

There’s a reason that you should separate costs into assets and expenses. Expenses are deductible against income, so they reduce taxable income. Assets, on the other hand, are not deductible against income.

By initially separating the two, you potentially save yourself money on taxes. Additionally, by accurately accounting for expenses, you can avoid overstating your assets on the balance sheet. While typically having more assets is a better look, having assets that are useless or unfounded only bloats your books and potentially makes them inaccurate. 

Listing these out separately is good practice when  starting a business  and leads into the final piece to consider when determining startup costs. 

3. Operating Expenses

Finally, figure out what it’s going to cost to keep your doors open until sales can cover expenses. Create a list that estimates monthly expenses, such as:

• Payroll (including your own salary)
• Marketing and advertising
• Loan payments
• Insurance premiums
• Office supplies
• Professional services
• Travel costs
• Shipping and distribution

Then, based on your revenue forecasts , calculate how many months it will take before your sales can cover all those monthly expenses. Multiply that number of months by your monthly operating expenses to determine how much you’re going to need to cover operating expenses as your business starts.

This number is often called “ cash runway ” and is a critical number – you need enough cash to fund those early red ink months. This number is how much cash you need to have in your checking account when you open your doors for business.

Calculating how much startup cash you need

To figure out how much money you need to start your business, add the asset purchases, startup expenses, and operating expenses over your cash runway period. This is your total startup costs, and it’s better to overestimate than underestimate these costs.

It often makes sense to invest the time to build a slightly more detailed starting costs calculation. Assuming you start making some sales and those sales grow over time, your revenue will be able to help pay for some of your operating expenses. Ideally, your sales contribute more and more over time until you become profitable.

To do a more detailed calculation, you’ll want to invest the time in a detailed financial forecast where you can experiment with different scenarios. If you do this, you’ll be able to see how much it will cost to start your business with different revenue growth rates. You’ll also be able to experiment with different funding scenarios and what your business would look like with different types of loans.

• Funding Starting Costs

You can cover starting costs on your own, or through a combination of loans and investments.

Many entrepreneurs decide they want to raise more cash than they need so they’ll have money left over for contingencies. While that makes good sense when you can do it, it is difficult to explain that to investors. Outside investors don’t want to give you more money than you need, because it’s their money.

You may see experts who recommend having anywhere from six months to a year’s worth of expenses covered, with your starting cash. That’s nice in concept and would be great for peace of mind, but it’s rarely practical. And it interferes with your estimates and dilutes their value.

Of course, startup financing isn’t technically part of the starting costs estimate. But in the real world, to get started, you need to estimate the starting costs and determine what startup financing will be necessary to cover them. The type of financing you pursue may alter your startup or ongoing costs in a given period, so it’s important to consider this upfront.

Here are common financing options to consider:

• Investment : What you or someone else puts into the company. It ends up as paid-in capital in the  balance sheet . This is the classic concept of business investment, taking ownership in a company, risking money in the hope of gaining money later.
• Accounts payable : Debts that are outstanding or need to be paid after a certain time according to your balance sheet. Generally, this means credit-card debt. This number becomes the starting balance of your balance sheet.
• Current borrowing : Standard debt, borrowing from banks,  Small Business Administration , or other current borrowing.
• Other current liabilities : Additional liabilities that don’t have interest charges. This is where you put loans from founders, family members, or friends. We aren’t recommending interest-free loans for financing, by the way, but when they happen, this is where they go.
• Long-term liabilities : Long-term debt or long-term loans.
• Other considerations for estimating startup costs

Pre-launch versus normal operations

With our definition of starting costs, the launch date is the defining point. Rent and payroll expenses before launch are considered startup expenses. The same expenses after launch are considered operating or ongoing expenses.

Many companies also incur some payroll expenses before launch because they need to hire people to train before launch, develop their website, stock shelves, and so forth.

Further Reading: How to calculate the hourly cost of an employee

The same defining point affects assets as well. For example, amounts in inventory purchased before launch and available at launch are included in starting assets. Inventory purchased after launch will affect  cash flow , and the balance sheet; but isn’t considered part of the starting costs.

So, be sure to accurately define the cutoff for startup costs and operating expenses. Again, by outlining everything within specific categories, this transition should be simple and easy to keep track of.

Your launch month will likely be the start of your business’s fiscal year

The establishment of a standard fiscal year plays a role in your analysis. U.S. tax code allows most businesses to manage taxes based on a fiscal year, which can be any series of 12 months, not necessarily January through December.

It can be convenient to establish the fiscal year as starting the same month that the business launches. In this case, the startup costs and startup funding match the fiscal year—and they happen in the time before the launch and beginning of the first operational fiscal year. The pre-launch transactions are reported as a separate tax year, even if they occur in just a few months, or even one month. So the last month of the pre-launch period is also the last month of the fiscal year.

• Aim for long-term success by estimating startup costs

Make sure you’ve considered every aspect of your business and included related costs. You’ll have a better chance at securing loans, attracting investors, estimating profits, and understanding the cash runway of your business.

The more accurately you layout startup costs and make adjustments as you incur them, the more accurate vision you’ll have for the immediate future of your business. 

Clarify your ideas and understand how to start your business with LivePlan

Tim Berry is the founder and chairman of Palo Alto Software , a co-founder of Borland International, and a recognized expert in business planning. He has an MBA from Stanford and degrees with honors from the University of Oregon and the University of Notre Dame. Today, Tim dedicates most of his time to blogging, teaching and evangelizing for business planning.

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How to create a budget for your business

January 16, 2024 | 7 minute read

If you want to increase the odds of having a successful small business, start by creating a budget. A budget is a powerful tool. It helps you understand how much money you have and what you’ve spent where — and provides clues about how much money you’ll need in the short and long term. It can also help shape key business decisions like whether to add staff and equipment or where to cut expenses to avoid cash flow issues .

A budget is critical, particularly at a time when companies are coping with rising costs. Seventy-nine percent of small business owners polled in Bank of America’s 2023 Small Business Owner Report said they are concerned about inflation and 68% said they are worried about commodity prices. Here’s how to create a budget and use it to make the best decisions today, tomorrow and in the future.

What is a business budget?

Simply put, a budget is a spending plan based on your business’ income and expenses. It shows your available capital, estimates spending and assists in predicting revenue. The information in your budget can help you plan your company’s next moves. A budget looks at activities for a specified time. Think of it as a tool to help you allocate resources toward the strategic priorities in your business plan.

What are the benefits of creating a business budget?

Budgeting enables you to allocate financial resources more effectively, track variances and make changes to your spending plan as needed. A budget provides a much-needed assist in maintaining daily operations, giving you the intel to deploy your cash more strategically so you don’t face a cash flow crunch. It can identify when you need to raise financing. Debt is a fact of life in many businesses. A budget can help you manage debts with controlled and planned financial activities.

A budget can also help you stay ready for the unexpected. Staying within your budget and creating a safety net for emergencies will give you a firmer financial foundation.

Types of business budgets

When it comes to business budgets, it’s not one and done. There are several types that may be helpful in your business.

Master budget

This type of budget uses inputs from financial statements, your cash forecast and your financial plan to create a single document you can use to keep your finger on the pulse of your business. Your management team can use it to plan the activities needed to reach business goals. Typically, small businesses use spreadsheets to create their master budgets or consider using budgeting software too, as it may help minimize mistakes.

Operating budget

This budget shows your projected revenue and expenses for a given period. Think of it as a profit and loss report , but for the future. The operating budget includes fixed and variable costs, as well as non-operating expenses. Capital expenditures are usually excluded from an operating budget. Each line item should be backed up with key details.

Fixed costs occur monthly.

Variable costs, like utilities , change depending on factors like usage.

Capital costs are one-time expenses, such as the purchase of a building.

The operating budget gives you a reality check on whether you’re spending according to plan. While this budget is often prepared at the start of each year, don’t set it and forget it. Update it throughout the year, be it monthly or quarterly, so you always know where your business stands.

Capital budget

Companies sometimes create a capital budget when they are looking to make a large purchase, such as a large piece of factory equipment or a new technology system that will require a substantial investment. This allows the finance team to determine the impact on cash flow and plan accordingly.

Cash budget or cash flow budget

This document will give you an estimate of how money comes in and goes out during a certain time horizon. You create a cash budget using the conclusions you draw from sales forecasts and production, and by estimating payables and receivables.

Labor budget

If you will hire employees , this type of budget is helpful in planning for the money you’ll need to meet payroll, not only for regular employees, but also for any temporary and seasonal staff.

Budgeting methods you can use

There’s more than one way to budget. Here are some common methods:

An incremental budget

This takes the current period’s budget or actual performance, uses it as a base and then adjusts it in incremental amounts to account for any increases in costs. Typically, when you put together an incremental budget, you use the rate of inflation as a guide for fine-tuning the amounts. One plus of budgeting this way is that it is relatively easy to do.

Zero-based budgeting

Here, you’re budgeting from scratch. You must scrutinize every expense or potential expense before deciding to add it to your budget. This helps you align your business goals with your expenses. Unlike other types of budgeting, it doesn’t focus on historical results. A zero-based budget is ideal when you’re looking to reduce expenses.

Activity-based budgeting

Actions speak louder than words. This type of budgeting looks at the inputs required to reach the targets or outputs set by the company. Say your business wants to achieve $5 million in revenue. First, you need to figure out the activities that need to happen to make that revenue a reality and then determine the costs of carrying out those activities.

Participative budgeting

There are more cooks in the kitchen with participative budgeting, which is often used by larger small businesses. Both middle management and lower levels of management share in the responsibility of putting together the budget. The budget begins with lower management then moves to middle managers before top management weighs in and signs off. An upside of this type of budgeting is that information is shared, and when management and staff are on the same page in terms of goals, they’re more likely to achieve those goals.

How to create a business budget

Creating a business budget takes several steps:

• Calculate your revenue . Include all your revenue streams, preferably over at least the last 12 months, to determine your monthly income. If your business is new, you can research what’s typical in your industry and use that as a guide to come up with estimates.
• Add up your fixed costs . Fixed costs are things like rent, payroll and debt repayment.
• Determine variable costs . In addition to utilities, these may include billable labor, materials, transaction fees and commissions.

Using a budget to make better decisions

If you make your budget a regular resource, you’ll be rewarded for your budgeting efforts. As you make spending decisions, consult your budget frequently and use it as a reality check. If you have budgeted for X amount and go beyond it, you’ll have some explaining to do, even if you’re only answering to yourself. Being disciplined can be challenging, but ultimately it will position your business for growth , both today and in the future.

Explore more

How to create a sales forecast

Understanding free cash flow

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