By Jim Welsh, Payroll4Construction.com

Breaking down labor costs on a job can not only be challenging but also misleading to say the least. For example, let’s say I have a job that I figure is going to take 100,000 labor hours to complete. I prepare an estimate for how much that labor’s going to cost, but I only calculate my labor rate with an average of what I guess my employees’ direct wages are, which I figure is around $50 per hour. By my estimate, my total labor cost is going to be around $5,000,000. I add a 50% markup — or $2,500,000 — to it, bringing my full labor estimate is $7,500,000. 

Right now, I’m pretty happy. I figure I’ll be making a decent profit just off of my labor. But as the job progresses, I notice my labor is costing me a lot more than I initially thought. The good news is I’m on schedule, but I’m already starting to have to dip into my would-be profits to make sure my employees are paid. At the end of the job, I realize I didn’t make nearly as much as I thought I would. 

This scenario is a little extreme, but it highlights the larger problem at hand. We all know employees cost more than just their wages, and it’s likely you already account for this when submitting an estimate, but exactly how much does that labor cost? Sure, wages make up the bulk of an employee’s cost, and we probably have a good, rounded guess of how much payroll taxes are within our home states, but there are still a number of other indirect costs employers pay for their employees that add up to a significant amount. Too often, these end up getting missed when determining the labor costs for a job — and when they’re not accounted for, it’s the profits that suffer. 

An easy way to narrow this gap is for subcontractors to become familiar with — and keep accurate tabs on — their labor burden rate. By knowing this figure, they can not only make more accurate projections on expected profits from a job but also know whether they’re charging the right rates for their employees’ labor. 

Direct Payroll Costs 

To calculate an accurate labor burden rate, it’s necessary to first separate the direct payroll costs from labor burden costs for your employees. 

Direct payroll costs are simply the wages that you pay your field employees. If an employee makes $40 per hour and works 40 hours on a job in a week, the direct payroll cost is $1,600. By totaling this number for each employee, you’ll get a full picture of direct payroll costs and what you’re paying in wages for your employees. 

If that were the end of it, payroll costs would be fairly simple to track, but employees cost more than just their base wage rate or salary. And aside from underestimating the amount of hours it’ll take to complete a job, these additional costs are also one of the most frequent causes of inaccurate estimates for labor cost. 

Labor Burden Costs 

An inescapable part of paying employees is also paying for the costs that exist outside of their wages. These indirect costs, also known as labor burden costs, are what get left behind most often when estimating the total cost for employees’ work. 

Labor burden costs include both mandatory expenses that you have to pay, like Social Security and Medicare, and voluntary expenses, like any employer-sponsored benefits. Some other examples of these costs include: 

• payroll taxes; 
• workers’ compensation;
• health and retirement plans;
• vacation times, holidays and sick days;
• and any required insurance for employees.

Labor burden costs could also be anything additional the company pays for on behalf of their employees, like training, uniforms or tools supplied by the company. 

Compared to direct payroll costs, labor burden is more difficult to accurately tally due to the variability of the rates involved. Certain amounts, like FICA taxes, have remained static at 7.65%, but others, like workers’ compensation and State Unemployment Tax (SUTA) rates, can be a bit more unpredictable since they’re dependent on both state-assigned worker classifications and rates. 

Additionally, while this number can be calculated off a weekly or quarterly payroll summary, there may still be some inconsistencies with projected amounts due to rate-variability and thresholds for certain taxes or benefits. Accounting or payroll software can usually assist in delivering a more narrowly defined summation for a company’s labor burden by either offering this rate directly or giving you the necessary reports to calculate it quickly, saving you from having to search through months’ worth spreadsheets for the necessary numbers. A construction-focused CPA could also always help calculate a more specific number for your employees’ labor burden costs. 

Finding Your Labor Burden Rate 

With direct payroll and labor burden costs calculated, you can now determine your labor burden rate. The formula for the labor burden rate is: 

Labor Burden Costs / Direct Payroll Costs = Labor Burden Rate 

Let’s say an employee has a labor burden cost of $25,000 and made $100,000 over the course of a year. By dividing his labor burden cost ($25,000) by his wages ($100,000), we find that his labor burden rate is 0.25. This means that for every $1 he earns, an additional $0.25 is paid to cover the cost of his burden. So if he makes $50 an hour in direct wages, his estimated wages on a job would be $62.50 an hour when adjusted for their burdened rate. 

The labor burden rate can fluctuate greatly since different benefits and tax variations can cause the labor burden cost to increase. For some businesses, it’s not uncommon for a labor burden rate to go as high as 0.70, or an additional $0.70 paid for every dollar in wages. 

Applying the Labor Burden Rate 

With a labor burden rate in hand, subcontractors can create a more accurate estimate with how much labor will cost on a job. Looking back at the original example, if I have a labor burden rate 0.50 for all of my employees that I didn’t account for in my estimate, I can only at best break even on the cost of my labor if I have a markup of 50%. But by using the labor burden rate as an adjusted rate to my initial labor 

cost prior to the markup, I can come closer to turning a profit on my labor. Of course, other aspects can still eat into these profits, like not having an accurate measure of my overhead or underestimating the amount of hours it’ll take to finish a job, so it’s still important to keep these additional costs and estimates in mind. 

It’s important to note that the labor burden rate isn’t a static figure. Benefits and taxes change; employees get raises — all of these result in changes to rate. While there’s no definite time that’s best to recheck your labor burden rate, it can be beneficial to recalculate this figure at least quarterly or after any raises. Of course, if you have access to accounting software or payroll reports, this rate can be tracked easily and checked with far more frequency. By keeping up with their labor burden rate and its impact on their labor costs, subcontractors can get a more precise read on what they should charge for their labor. 

Jim Welsh started at Payroll4Construction.com in 2010, bringing with him both industry experience as a mason and sales knowledge as an insurance agent. As a national sales representative for Payroll4Construction.com, Jim works with contractors to fully explain the benefits of outsourcing their payroll and how a construction-specific provider, like Payroll4Construction.com, can easily handle their processing, taxes and reporting tasks. jfw@foundationsoft.com | (800) 949-9620