If you hear the term “Labor Burden”, and you want to glaze over a bit, don’t.
Understanding Labor Burden, as applied to the direct hourly cost of your billable labor (Technicians, Engineers, Programmers, Project Managers, etc.), may just change your business. It is a crucial concept in running a profitable company, which helps managers understand the true costs and resulting profitability of people, projects and departments. It also helps to determine how you should be pricing your labor, and when to hire more when needed.
For the moment, let’s forget about equipment and materials, and propose that all of us are in the business of only selling and providing labor. General labor, expert labor, extraordinary labor, installation labor, engineering labor, commissioning labor, service labor, etc. “Burden” then is the heavy weight of company cost that each labor hour must cover in order for the business to earn a profit.
There are five basic elements to understand for this analysis. Direct Labor Cost, Burdened Direct Labor Cost, Indirect Labor Cost, Overhead, and Fully-burdened Direct Labor Cost. They should not be hard to grasp or communicate, but they are important for the business to capture and monitor, and essential to mature management.
1. Direct Labor Cost
This is the hourly amount you pay an individual to perform tasks toward the completion of identified projects.
2. Burdened Direct Labor Cost
This adds all additional costs required to employ the individual – such as Payroll Taxes, vacation and sick days, health care paid by the company, matching 401K costs, training and development (course costs plus training time away from work), other non-billable time, and any other expenses paid on behalf of the company (like maybe a computer or cell phone). In other words, employing this person carries a burden above and beyond his basic compensation.
3. Indirect Labor Costs
This includes all labor costs associated with producing the customer outcome that cannot be directly charged to a project. These might include some project management, administration, procurement, and pre-sales engineering.
4. Overhead Costs
These are costs required for the business to exist. Facilities, insurance, utilities, IT infrastructure, software, etc. The Cost of Selling (salaries, commissions for example) is a special category that falls into Overhead Costs. Sometimes Overhead Costs are broken out as General, Administrative and Selling.
5. Fully-burdened Direct Labor Cost
This captures all general overhead and indirect costs that can’t be attributed to the individual or project. These are added together and then divided by the total number of total chargeable direct labor hours. This cost per hour now includes all the company’s costs for running the business (with the exception of equipment and material costs attributed to projects).
Each chargeable employee has his or her individual Burdened Direct Labor Cost. To better understand the whole company, here is a quick analysis of average Fully Burdened Direct Labor Cost. With a little more effort you could do this by labor type or department.
Here’s a recent example from a real company.
Average Fully Burdened Direct Labor Cost per Hour
|Total number of Chargeable Direct Labor employees||32||All billable Direct Labor employees|
|Total number of Direct Labor Hours||66,560||Number of employees X 2080 hours per year|
|Less Vacation, Holidays and Sick Time||(5,120)||20 days (2wks vacation plus 10 holiday/sick days) X 8 hours|
|Total Company Available Hours||61,440|
|Estimated Utilization Rate||70%||How much labor time actually gets charged to a project|
|Total Company Chargeable Hours||43,008|
|Total Direct Labor, Indirect Labor and OH||$4,822,574||All annual costs except products and materials|
|Average Cost per Chargeable Labor Hour||$112.13||Annual costs divided by Chargeable Labor Hours|
What does analyzing your company in this way allow you to do?
- Price your labor hours for profitability.
- Accurately determine your “real” gross profit on projects.
- Estimate, schedule and utilize your labor resources more accurately and efficiently.
- Understand your company’s real profit engine.
- Determine how efficient your company is per Chargeable Direct Labor hour.
Knowing the Fully-burdened Direct Labor Cost attributed to the labor hours of the company can actually “lighten the burden” of management decisions when it comes to controlling costs. It allows managers to adjust the ratios of Direct, Indirect and Overhead costs and highlights many management decisions to improve utilization, chargeability and profitability.
So, Labor Burden shouldn’t put you to sleep. Rather, Labor Burden is an important often overlooked metric that needs to be calculated on an at least an annual basis.
If you haven’t done it recently, now would be a good time.