# Labor Cost Calculator

*“Managerial Economics and Business Strategy“*(2009)

Employ the **labor cost calculator** to **estimate the actual hourly labor cost of an employee**. Read further to get an insight into *what labor costs are* and *how to calculate labor cost* with a step by step procedure including the related labor cost formulas. After reading you will be able to better answer "How much does an employee cost?" You may also check some of the below calculators which were created for other types of cost:

## What are labor costs?

If you were running a business and reached a point where you were considering hiring someone, or you already have an employee, one of the first questions comes to your mind was probably "How much does an employee cost?" So what is labor cost? **Labor cost is the sum of all wages paid to employees** which include not only remunerations for the actual work but also cover other expenses such as the cost of employee benefits and payroll taxes paid by an employer. The following list includes the most common additional expenses, which can all be part of the labor cost:

- Payroll taxes;
- Overtime;
- Health care;
- Bonuses;
- Sick days;
- Vacation days;
- Insurance;
- Benefits;
- Meals;
- Supplies; and
- Training costs.

## Direct and indirect labor costs

We can classify labor costs into **direct and indirect (overhead) costs**. How to calculate direct labor cost? It's straightforward: the direct labor cost formula consists of all wages paid for employees directly involved in production. In contrast, wages related to support labor and production, such as employees who maintain the factory equipment, are indirect costs.

Besides, labor costs can be fixed costs or variable costs. For example, the labor cost related to operating machinery that depends on the factory's output is a variable cost. On the other hand, fixed labor costs cover employees' labor, mostly with long-term contracts that don't depend much on production.

## How to calculate labor cost? Labor cost calculator

Our labor cost calculator applies the below procedure explained through an example for a hypothetical restaurant.

**Compute Gross Pay**

If your employees work full time, they will typically work `40 hours per week`

. By multiplying the average number of weeks in a year, you will get the related gross hours per year (`40 * 52 = 2,080 hours`

). Let's say this employee earns `10 dollars per hour`

, then the gross pay is equal to `2,080 * 10 = 20,800 dollars per year`

.

`Gross hours per year = Gross hours per week * 52.`

`Gross pay = Pay rate * Gross hours`

**Estimate the net hours worked in a year**

To estimate the actual number of hours worked in a year, you need to know how many days an employee is absent in a year. If you would like to apply the labor cost calculation on a future employee, you can take the current staff's average number. For example, suppose a typical employee is absent 15 days a year due to a holiday or illness. In that case, you can get the yearly days of absence quickly by multiplying by the daily working hours (or weekly hours divided by working days), which is in the present example:

`Hours not worked = 15 * 8 = 120`

.

Then subtract it from the gross hours:

`Net hours worked = Gross hours – Hours not worked = 2,080 - 120 = 1,960.`

**Sum additional annual costs**

As we stated at the beginning, to get the real labor cost, you need to include all related expenses related to employment.

`Other annual costs = Taxes + Insurance + Benefits + Overtime + Supplies`

**Compute Annual payroll labor cost**

After computing all the above components, we finally arrive at the main labor cost formula, which tells us how much does an employee cost in a year:

`Annual payroll labor cost = Gross pay + Other annual costs`

Let's say the additional costs are 3,900 dollars per year. To get the annual labor cost, you need to add this to the Gross pay, which was 20,800 dollars: `20,800 + 3,900 = 24,700`

.

**Estimate Actual hourly labor cost**

You can also estimate the actual hourly labor cost by dividing the Annual payroll labor cost by the worked hours.

`Actual hourly labor cost = Annual payroll labor cost / Net hours worked`

So how much does labor cost per hour in our example? Recall that the net hours worked in a year was 1,960 hours. Dividing the 24,700 dollars payroll cost by the new hours worked, we get a 12.60 dollars actual hourly labor cost.

**Approximate Labor cost percentage**

To better insight on how much does an employee cost, you can also check the labor cost percentage, which is the relationship between your labor cost and your total revenue over a period. So how to calculate labor cost percentage? Just apply the following labor cost percentage formula to get the answer.

`Labor cost percentage = Annual payroll labor cost / Total revenue`

If our hypothetical restaurant's revenue is, let's say, 80,000 dollars in a year, the Labor cost percentage is `24,700 / 80,000 = 30.9 %`

.

Note that the acceptable labor cost percentages are around 25 and 40 percent for a restaurant. The ratio varies by industry, however. For example, businesses in the service sector might expect the ratio to be 50 percent or more, but the figure may be under 30 percent in the manufacturing sector.