Labor Cost Percentage – Are You Spending Too Much?

Labor costs add up. Everyone in business knows this. No matter what industry you’re in, labor costs are rising due in part to new minimum and overtime wage laws, expectations around parental leave and other benefits, and an increased consumer demand for American-made goods. 

The thing about labor costs is there’s no standard across the board. Percentages vary by industry, company size, and revenue. No two companies are alike. 

Here, we outline what comprises labor costs to help you figure out if you’re spending too much, where you may be doing so, and how you can reduce these costs the smart way. 

An Overview of Labor Cost Percentage

The labor cost percentage of a business is its overall payroll amount relative to its gross sales. Payroll is a significant expense for most businesses; depending on the industry, it may be the biggest cost

If you’re calculating the annual employee labor percentage, use gross sales from an annual income statement. If you’re measuring a shorter period like a week or month, you can run sales reports. 

Payroll is the list of a company’s employees and the amount of money they are to be paid. When calculating payroll, it’s worth remembering that it includes more than just the hourly wages of employees. You should generally be accounting for:

  • Salaried employee wages
  • Hourly wages
  • Bonuses
  • Payroll taxes
  • Health care
  • Overtime
  • Sick and vacation time

Revenue is cash generated by gross sales.

The following sections describe what you need to determine, in order to streamline labor costs the smart way. 

How to Calculate Labor Cost Percentage

You need to know your business’s gross sales and the total outlay for payroll. To calculate the labor cost percentage, divide your labor cost by gross sales. Multiply the result by 100. Let’s say gross sales are $500K, with a total labor cost of $140K. Divide $140K by $500K, then multiply by 100. Your employee labor percentage is 28%.

Here’s Our Step-by-Step Breakdown

1. Calculate Total Revenue

Total annual revenue is the gross sales found on the top of your annual income statement. That’s a straightforward read. 

2. Calculate Total Payroll Costs

Total payroll costs can be calculated by adding up expenses that go into employee wages and salaries, but don’t forget to include bonuses, commissions, benefit packages, healthcare, etc.

If a worker is regularly working overtime, this needs to be taken into account. The standard OT rate is time and a half. If their regular rate is $10, an additional $5 will be added on as the half, which makes the hourly rate $15 per hour after 40 hours worked. 

You’ll need IRS Publication 15, Circular E, Employer’s Tax Guide to find the exact amount to withhold. Software like Patriot is designed specifically for streamlining all of these kinds of numbers.

Next, you have to check for state income tax. Your state’s Department of Revenue site will have all of the information. The same goes for Social Security and Medicare withholding as a percentage based on gross pay

All of this is not necessarily another straightforward equation, but you can do this with or without payroll software.

3. Labor Cost Percentage Formula

Once you have these two numbers, divide the labor cost by gross sales and multiply the result by 100. 

For example, if you paid $300K a year to employees and brought in $1M a year in sales, divide $300K by $1M to get 0.3. Multiply by 100. This final number is your labor cost percentage. In this example, it’s 30%.

(300,000 ÷ 1,000,000) × 100 = 30% 

You can also calculate labor percentage on a more granular—monthly or weekly—level if you’re trying to determine if there are specific periods in which your labor costs are eating up more of your earnings. 

How to Decrease Labor Costs

You can determine what’s a good labor to sales ratio and whether or not to decrease labor costs to get there.

Labor cost should be around 20 to 35% of gross sales. Cutting labor costs is a balancing act. Finding ways to streamline labor costs is rooted in reducing costs without sacrificing workforce morale or productivity. 

Despite what you think is driving up costs, hiring more workers isn’t usually the culprit; it’s actually overtime. Those time and a half hours add up, and according to the Bureau of Labor Statistics, it accounted for 4.6% of total statewide revenues. And it’s just not hourly workers either. Even some salaried contracts are structured in a way that if a worker works over their allotted 40, there are overtime perks written in. 

This is where effectively scheduling employees is critical. Luckily, there is overtime software that even gives warnings if costs are getting too high. 

Starting in January, 2020, the Department of Labor passed new federal laws around worker compensation allowing employees to more easily acquire overtime hours, which, at this scale will affect up to three million workers. 

According to the Department of Labor, the final rule:

  • Raises the “standard salary level” from the currently enforced level of $455 to $684 per week (equivalent to $35,568 per year for a full-year worker);
  • Raises the total annual compensation level for “highly compensated employees (HCEs)” from the currently-enforced level of $100,000 to $107,432 per year;
  • Allows employers to use nondiscretionary bonuses and incentive payments (including commissions) that are paid at least annually to satisfy up to 10 percent of the standard salary level, in recognition of evolving pay practices; and
  • Revises the special salary levels for workers in U.S. territories and in the motion picture industry.

The relevant provision states “that exempt salaried employees must be paid at least $684 per week, or $35,568 annually. Employees who do not meet this salary level must be classified as non-exempt, and be paid overtime for all hours worked over 40 in a workweek,” according to NFIB.

Other factors to consider are fair workweek laws, parental leave, living wage ordinances, and the rise of the minimum wage across the board. Fair workweek laws require employers to create schedules ahead of time while paying a premium if the schedule changes or if employees have to work outside scheduled hours. The same goes for employers who cut hours, which would drastically affect an employee’s livelihood. 

And then there’s healthcare, vacation time, bonuses, and sick leave. All of these things add up. With margins being razor-thin as it is, one unexpected change could flip everything on its head.

A simple way to manage overtime costs is by making sure the business is properly staffed. Having enough workers to handle the hours needed to cover your business is one way to avoid massive labor costs.

Adia Provides a Solution to Rising Labor Costs

Make sure you’re adequately staffed by scheduling enough people and having some in reserve. 

Can you handle an increase in demand without stressing? Do you have enough workers to cover a major boom in the industry? Both of these factors play into overhead. 

This is a perfect example of where Adia can help. No matter what your industry, consider on-demand staffing. Our technology provides you with our W-2 workers on an as needed basis, or as a solution to more permanent hiring needs. 

The Adia community has over 10X the workers of a traditional staffing or temp agency. You enter the amount of workers you’re looking for and we’ll match you with a vetted, experienced workforce. 

You’re in charge of the hours, the price, and who’ll be clocking in come Monday. We carry insurance, sick time, and since they’re our W-2 employees, yes, their overtime. Even better? Because we’re a “business expense,” we’re a tax write off just the same as buying a stapler or a new copy machine. 

Staffing with Adia makes getting the job done a lot easier – and faster.

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