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The True Cost of Labor

I laugh at the definition of labor costs because in my opinion the so called experts only have it half right.  Labor costs are more than just gross wages and benefits.  It should include the costs of insurance, employer taxation, human resources management and incentives.  All of the costs associated with delivering the human element of service should be included.  Let’s explore these costs from the most expensive to the least.

Gross Wages

Typically this includes hourly based, salaries, production based compensation and commissions.  These are the core wages paid to all employees rendering the service.  This line item will definitely be the most expensive element in the Costs of Services Rendered (CSR) section of the Profit & Loss Statement.

Benefits

The second most expensive section of the CSR is benefits.  This includes health insurance provided by the company, retirement benefits, other forms of medical and life insurance.  Sick leave to vacation time is included here.  For a professional environment this will get to be in the 19% or more range as a percentage of the CSR.  For more production based environments such as trade services or volume based human services, the benefits section will drop down into the 11% area of the total CSR.

Insurance

Note that health insurance and other forms of medical benefits are included in the Benefits Section.  This respective type of insurance explained here includes workman’s compensation and professional liability insurance.  Many professional organizations have to provide errors and omissions insurance and this is a cost of labor.  These types of businesses include insurance agents, real estate agencies, engineering and architectural firms.  Lawyers and accountants have to purchase this type of insurance too.  Medical professionals purchase a professional liability policy and often purchase what is known as tail insurance (covers errors made in the past by a staff member when that staff member retires or departs the practice).  Depending on the nature of your business this will range around 8 to 11% of the CSR section.

Employer Taxation

This covers the matching requirements for Social Security Taxes and Medicare.  In addition every business pays FUTA  (FUTA: An Explanation to the Federal Unemployment Tax Act) and some form of state unemployment taxes.  In addition, many of the professional licensed businesses require annual licenses for their employees.  From the hairdresser to the doctor, many states and federal agencies require a license to operate.  Licenses are customarily issued to individuals.  This section ranges from no less than 8% to as much as 10% of the CSR section of the Profit and Loss Statement.

Human Resources Management

One of the lesser cost elements is human resources management especially if the cost is spread over many years for the staff.  This includes the cost of the administrator and the software used to track the staff’s production.  It includes training, documentation, and the review processes in the company.  From advertising for the position to the termination process, human resources management is going to run around 3% of the total CSR.

Incentives

Bonuses and other forms of compensation to employees to either increase or maintain a high level of production are included here.  From the annual gift card or turkey to out-right production based bonuses, this line item in the CSR has a wide range of value.

So a well laid out Cost of Services Rendered section of the Profit and Loss will look like this for a small service based business:

Gross Wages                 $ZZZ,ZZZ    (Core Compensation)
Benefits                             ZZ,ZZZ     (Time Off, Health Insurance, Retirement)
Insurance                           ZZ,ZZZ     (Workman’s Comp and Professional)
Taxes & Licenses              ZZ,ZZZ     (IRS Matching, FUTA, SUTA, Professional Licenses)
Human Resources               Z,ZZZ     (Administrator, Software, Hiring/Termination Process)
Incentives                            Z,ZZZ     (Bonuses, Gifts)
Total Cost of Services Rendered          $ZZZ,ZZZ

If your company is services based, then your Cost of Goods Sold section or properly worded, Cost of Services Rendered, should have the above identified line items in the report.  This will allow management the opportunity to identify trends and or issues as it relates to the total revenue generated.  Overall, in a service based organization, CSR is going to run from 65% to 70% of the total revenue generated.  So it is important to understand this section of the report and what the true cost of labor runs for the company.  Act on Knowledge.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org.  I would love to hear from you.  If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer. 

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About David J Hoare (386 Articles)
I spent 12 Years as a Certified Public Accountant, Over 20 Years of Practice in Accounting and Consulting, Controller in Management of Closely Held Operations, Masters of Science in Accounting, Prepared over 1,000 Business Tax Returns and Hundreds of Individual Returns

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