If you seek to run a profitable construction business, then you need to know exactly what running that business costs you and control every expense. That insight will allow you to estimate accurately and bid competitively while also employing workers with fair compensation and meeting all employer-related tax requirements.
So, why use a fully burdened labor rate? Because employing a worker costs more than just their hourly wage – there is a “burden” of additional costs you’ll incur.
That is to say, the unburdened labor rate is the basic compensation paid to employees. Yet, the real cost or of an employee can only be seen in a burdened labor rate, which has mandatory and voluntary inclusions, as follows:
- Those burdens that are mandatory are payroll taxes (Social Security, Medicare), federal and state unemployment insurance and, if state requires it, also workers' compensation insurance, liability insurance, and state disability insurance. Your state or local government may also require a local payroll tax and job-training tax.
- Other labor burdens may be deemed as voluntary. Those can include health insurance, life, disability, and accident insurance, as well as other costs and benefits such as vacation pay, sick pay, retirement benefits, etc. While these are voluntary, knowing your burden rate can help you determine if and how you can afford these benefits as an investment to attract and retain the talent you want to employ.
- Additional costs incurred for having employees to be captured in your fully burdened labor rate can include company vehicle, business travel, training, cell phone usage, and uniforms in addition to their hourly rate.
While you recognize that all of these costs associated with employment will increase your total cost, it’s important to also notice that labor burdened rates do not include any markups or profits related to the labor or expenses not associated with employee compensation (more about markups later).
It’s easy to appreciate how the “burden” will impact your business decisions, estimating, and overall profitability, and it’s clear to see how important it is to know and control your employee expenses.
Calculating Your Burdened Labor Rate
Calculating your fully burdened labor costs can help you make better decisions about your budget and workforce. The burdened labor rate is a way to find the indirect costs of your labor force and compare indirect costs to direct costs.
As we’ve outlined so far, those indirect costs are necessary running your construction business and will certainly impact your company’s profit margins and final sales price. That’s why it’s essential that contractors appropriately allocate indirect costs to specific jobs and accurately manage with a true cost structure.
Identifying and budgeting those indirect costs isn’t always straightforward because the costs aren’t always apparent. We’ve identified the indirect labor costs such as vacation time and insurance, but there are other indirect costs that must be accounted for, including tools and equipment, repairs and maintenance, depreciation, rent, supplies, and vehicle-related costs – some of these costs are fixed and others will fluctuate. It’d be wise to review calculations every six months and adapt to changes as needed.
So that addresses why and when to consider your indirect costs and calculate your burdened labor rate – now let’s address how.
To determine a labor burden rate or fully burdened cost per production hour, it’s common among contractors to estimate the indirect cost pool and divide it by labor hours. That calculation is:
Employee’s Fully Burdened Labor Rate or total employee cost = (Labor Burden Costs PLUS gross payroll labor cost) DIVIDED BY the number of hours (production).
* Remember, labor burden costs are those beyond gross compensation.
When you utilize that modest but powerful equation as your labor burden rate calculator, and perform these calculations for your employees, you may realize that workers can typically cost you between 50-150 percent above their hourly wage. You’ll quickly appreciate how knowing your true labor costs – only possible using fully burdened labor rate – can make a dramatic impact on your success (or struggle) in the labor-intensive construction industry.
Side note: If you run a construction company that’s equipment-intensive, such as excavation or site work, then your indirect cost pool likely includes a large amount of fuel, repairs, maintenance, depreciation, etc. Using an equipment burden rate in addition to a labor burden rate may be wise. To determine that figure, identify the indirect cost pool, and then divide that by equipment hours, and then allocate those costs into jobs using an hourly equipment burden rate.
Mistakes to Avoid in Estimating
With an eye on estimating for profitability, it’s important to know all the numbers you’re working with and be consistent in your calculations as you focus on using a fully burdened labor rate. This will help you avoid common mistakes, specifically underestimating your employee total cost and fumbling the job sales price.
For example, will you keep all labor-related costs in your overhead? Then when you calculate your markup and do your estimate using a fully burdened labor rate, you’ll be adding overhead to your sales price twice – in your labor rate and in your markup – and ending up with a price much higher than it should be.
This example can go the other way, too, if you are deducting labor-related expenses from your overhead when you calculate your markup, but estimate using the employees’ hourly pay rate. This will mean you’re losing money because you’re pricing too low.
What’s important to remember is to use the rate depending on what you included in overhead when you calculate your markup – and of course, your markup is based on your company’s specific situation. When estimating your job costs, consider the assumptions you made when calculating your markup. The key point here is to account for your payroll taxes and benefits just once when you quote a job.
Managing with attention to labor burden is an important part of your construction company’s cost structure. Effectively allocating indirect costs will change how accurately your jobs are reported. Determining a fully burdened labor rate in construction gives owners, estimators, project managers, and accounting much valuable insights and financial metrics to drive pricing. In short, it will allow better decision-making to establish benchmarks, guide pricing, and improve profitability.