Every business has to consider direct labor vs indirect labor costs when contemplating contracts. For craftworkers and construction companies, these costs are important in determining whether or not to take a contract.
But what type of labor is included in each and how are you expected to calculate the supposed expenses?
We’ll take you through all the important bits here. By the time you finish, you’ll know exactly what should be grouped under each type, how to calculate it and what the ideal numbers should be.
Direct Labor vs Indirect Labor
“Labor” is defined as the total amount of expertise and manpower needed to finish a job. It is further broken into two main categories: direct and indirect labor.
Direct labor is easy to understand and identify. Very simply, it’s the wages you pay employees. However, these expenses include any benefits that are provided to that employee, as well, such as healthcare.
In a typical contract, businesses will pay salaries and benefits to company employees and hourly or pre-project costs to contractors.
The direct costs include only the employees who will work directly on the project. Support staff (human resources, administration, etc.) are categorized differently.
Examples may include the following:
Indirect labor supports the company, but individuals do so from a distance. These employees are not actively involved in the construction or planning.
Examples of indirect labor positions include the following:
- Human resources
- Customer relations
While just as integral to a company’s success, these employees work “backstage.”
An easy way to tell the difference is by connection: if you cannot relate an employee’s job directly to one specific project, they are categorized under indirect labor.
Although labor will vary depending on the scope of each contract, there are general numbers that may help contractors and construction companies.
Construction Business Owner magazine points out a typical $115,000 contract allocates $40,000 to labor alone. This is about 35% of the total contract cost, although anywhere between 30% to 40% is not uncommon.
Understanding direct and indirect costs can save companies money and even stop them from falling apart.
The labor burden includes the direct and indirect expenses of hiring and employing an individual. It’s an easy way to see how much money a company can expect to pay for labor.
In addition to paying an employee’s wage, there are several factors that increase the total cost of an employee:
- Sick days
- Paid leave
- Worker’s compensation
- Payroll taxes
If these hidden costs climb too high, a company can go out of business.
Furthermore, tracking and comprehending labor is an easy way to make higher profits. The average construction company only earns 2% to 3% in profits annually. By reducing labor even 5%, companies and contractors can improve this net profit to 4% or 5%.
Knowing where to cut safely increases savings. A 20-person crew saves up to $2,500 per year or more with every 60-second improvement.
How to Calculate
If you’re not the accountant type, don’t sweat it. Calculating labor burden involves changing the indirect costs into a percentage of the direct labor costs.
Doing so will tell a company how much it is truly spending on labor:
INDIRECT COSTS/ DIRECT COSTS * 100 = LABOR BURDEN
Tracking down all the numbers is the hardest bit of this equation, but it’s necessary for a company’s success.
However, don’t stop there. To truly turn this to your advantage, use the labor burden to determine the labor price. Finding the labor price depends on your markup, the amount of profit you plan to make:
LABOR WAGE x LABOR BURDEN FACTOR x MARKUP = LABOR PRICE
Once again, it’s easy to see how the direct and indirect labor costs can play a vital role in your company’s future.
How to Obtain Optimal Numbers
So now you’re probably wondering how you can possibly cut anything from direct and indirect labor. Many solutions are easier than you might think.
Every minute counts. Take a hard look at clock-in and clock-out times. Are workers clocking out at 3:15 instead of 3:30?
Those 15 minutes can cost you over $30,000 if you have a 20-person team.
Take advantage of apprenticeship programs to further cut costs. Many students studying particular trades can benefit from such a program, and they almost always work for free.
Next, check in on efficiency. Is your crew standing around or are they actually getting the job done? Incorporate company policies that clarify production expectations, breaks and clock-in and out times.
Analyzing indirect labor is just as important. How many people are necessary to adequately provide for the company? Some construction businesses have a single person behind the curtain.
Finally, use technology to your advantage. Keep track of everything and stay organized. It can seem overwhelming, but there are many new software programs and platforms available to help contractors and businesses keep tabs on costs.
Many can even increase production.
Contemplate wearable technology for your employees, digitize timekeeping and utilize virtual reality for training and planning.
Additional Costs to Consider
Bear in mind that labor costs are not the only expenses contractors and owners must contemplate. Indirect materials and overhead costs also play a factor in a company’s success.
Indirect materials include construction materials that are too much of a hassle to bother keeping track of. For example, counting the number of nails and staples required for a project would take more time than it would be worth.
Examples of indirect materials are abundant:
Fixed manufacturing overhead costs include expenses that stay relatively the same regardless of the project. These can include tool rentals, safety equipment, insurance premiums and more.
Finally, variable overhead costs will also add to expenditures. Unlike fixed overhead, these costs vary with the amount of production. They are mostly made up of supplies and utilities.
Don’t forget to allocate for each.
Organize Your Business With Rhumbix
Comprehending and tracking direct labor vs indirect labor is an easy way to increase annual profits, provide labor costs and assess production.
However, putting it all together can become of a jumble of numbers that result in a splitting headache. Don’t let the stress increase your burden.
Rhumbix is a convenient app that lets owners collect, analyze and optimize labor productivity. Use it to keep track of everything you need and take it with you wherever you go.
If you want organization and increased production, give Rhumbix a try. Request a free demo and start lowering your company’s labor costs today.