What Is the Cost of Labor?
Let me explain to you what the cost of labor really means. It's the total sum of all wages you pay to your employees, plus the costs of their benefits and the payroll taxes you handle as an employer. You need to break this down into direct and indirect costs—direct ones cover wages for employees who actually produce your products, like those on an assembly line, while indirect costs involve support roles, such as workers maintaining factory equipment.
These costs, which we call the burden rate, include every auxiliary, indirect, and incidental expense tied to hiring and keeping an employee on board.
Key Takeaways
You should categorize labor costs into direct (production-related) and indirect (non-production) types. Direct costs go to employees producing products, including assembly line workers, whereas indirect costs support labor like equipment maintainers. If you don't allocate or evaluate these costs properly, it can shift the price of your goods or services away from their true cost, ultimately damaging your profits.
Understanding Cost of Labor
When you're setting the sales price for a product as a manufacturer, you have to factor in labor, material, and overhead costs. The sales price must cover all these total costs; if you leave any out, your profit will be lower than you expect. If demand drops or competition forces price cuts, you need to reduce labor costs to stay profitable— that means cutting employees, scaling back production, boosting productivity, or trimming other production factors.
In some industries, like hospitality, you can shift labor costs directly to the consumer through practices like encouraging tipping, which lets businesses lower their own labor expenses.
The Differences Between Direct and Indirect Costs of Labor
Take XYZ Furniture planning prices for dining room chairs as an example. Direct labor costs are those you can trace straight to production—think paying workers to operate machinery that cuts wood for chair assembly. On the flip side, costs for employees providing factory security are indirect because you can't link them to a specific production act.
Examples of Fixed and Variable Costs of Labor
Labor costs also fall into fixed or variable categories. Variable costs, like labor to run machinery, change with your production levels—you can increase or decrease them by adjusting output. Fixed costs might include set fees for long-term service contracts, such as hiring an outside vendor for equipment repair and maintenance.
Factoring in Undercosting and Overcosting
Allocating indirect labor costs to the right product or service can be tricky, leading to undercosting one item and overcosting another, which messes up your pricing. For instance, if XYZ manufactures dining room chairs and wooden bed frames with $20,000 monthly machinery labor costs, allocating too much to bed frames means too little for chairs—resulting in incorrect costs and sale prices that don't reflect true expenses.
Cost of Labor vs. Cost of Living
Don't mix up cost of labor with cost of living—the former is just the total wages paid to employees, while the latter is what it takes for a consumer to maintain a standard of living in a specific area, covering housing, food, transportation, and more. These can be much higher than labor costs in places like New York City, where demand drives up prices for housing and food.
Other articles for you
A widely held fixed investment trust (WHFIT) is a type of unit investment trust involving a third-party middleman that holds shares and distributes income from a fixed portfolio to investors.
Alpha measures an investment's ability to generate excess returns over a benchmark, adjusted for risk.
The hot hand is a psychological belief in continued success after a streak, often debunked but supported in some sports contexts.
The Occupational Safety and Health Act of 1970 established OSHA to enforce workplace safety standards and protect employees from health hazards.
Equity-linked securities are debt instruments offering variable payments tied to equity market benchmarks, serving as an alternative for raising corporate capital.
Uninsurable property refers to homes or assets that insurers, particularly the FHA, decline to cover due to needed repairs or risks, though alternatives like 203K loans exist.
Cash surrender value is the amount a policyholder receives when canceling a permanent life insurance policy before maturity or death, representing the policy's accumulated savings minus any fees.
The Rule of 72 is a simple formula to estimate how long it takes for an investment to double based on its annual compounded return rate.
Yellow sheets are bulletins that provide key data on over-the-counter corporate bonds for traders.
The European Central Bank (ECB) manages monetary policy for the Eurozone to maintain price stability.