Running a manufacturing company successfully largely depends on how you manage the workforce. Labor is the most critical resource in a company, and HR managers must ensure that workers are managed efficiently. To be profitable, manufacturing companies are required to keep labor costs low.
Unfortunately, many managers need to know how to calculate manufacturing labor costs. It is an important metric, and companies must analyze it for profit and loss. If you want your organization to handle poor efficiency and overspending, it’s essential to know how to calculate labor costs.
In this article, we will explain how labor costs are calculated in manufacturing.
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What is the labor cost in manufacturing?
The labor cost in manufacturing is the total amount spend on workers by the company. It includes not only wages but also contract workers’ costs, taxes of labor costs, bonuses, and other costs such as employee compensation schemes.
A company has to bear many costs apart from salaries, such as overtime, maternity pay, sick pay, and investments in training costs. The overall labor cost is much more than the basic employee salaries, so it is essential to keep track of the overall labor costs in manufacturing. It is necessary for smaller businesses where labor costs can make up a large percentage of the overall business operations costs.
What's the difference between direct and indirect costs?
To calculate the labor cost in manufacturing, you must understand the direct and indirect costs.
Direct costs are the expenses associated with the specific object that is directly used in the production of the product in the company. For instance, the raw materials and tools used for manufacturing the products are direct costs.
If the employee is directly working with the raw materials or the tools in the manufacturing unit, then their salary is a direct labor cost. For instance, in a juice-making factory, the workers who control the ingredient mixing machines are direct laborers. Usually, the salaries of engineers, production supervisors, assembly line workers, and truck drivers are direct labor costs. You must know how to calculate direct manufacturing labor costs to reduce production costs.
Indirect labor costs are expenses not directly associated with a specific product or tool used for manufacturing products at the company. A typical example of indirect cost is administrative expenses. The indirect labor costs are the salaries a manufacturing company pays to payroll staff, administrative assistants, sales team members, and office managers.
These costs are indirect because they are not directly linked to the products you manufacture but are part of the company’s overhead and relate to the entire business. Indirect costs also include rent, depreciation, insurance, and quality control. But you must recognize that these costs are unnecessary if they don’t directly contribute to the manufacturing process. Such expenses are required to ensure the business runs successfully.
Any opportunity costs are also considered indirect. It is the money that your company loses because of performance issues.
How to calculate manufacturing labor costs
Now that you understand the direct and indirect labor costs, here’s how to calculate labor costs in manufacturing. There are three significant aspects.
1. Calculate the hourly labor rate
Calculating the direct hourly labor rate is the sum of all the wages, taxes, and other cost benefits for a given period divided by the number of work hours for that given period.
The hourly labor rate is calculated as follows:
Wages + taxes + other benefits / Number of hours worked during the pay period
2. Calculate labor hours
It is the calculation of the labor hours put into producing one unit of your product. It is one of the essential metrics to calculate the labor cost in manufacturing. Divide the number of units produced by the labor hours required to make the units.
The formula for labor hours is:
Units produced / labor hours needed to make the units
3. Calculate labor cost per unit
The labor cost per unit is the multiplication of the hourly labor rate by the labor hours per unit. Once you have calculated the hourly labor rate and labor hours, you can calculate labor cost per unit as:
Labor hourly rate x labor hours
The final labor cost per unit will help you establish how much portion of the overall expenditure is attributed to the labor cost in manufacturing. Based on the outcome, you can implement one of the following ways to reduce the manufacturing labor cost.
How to reduce manufacturing labor costs
1. Track employee work hours
Employee work hours tracking errors can have costly ramifications for the manufacturing business. You will be paying for the hours workers did not work. This is why you must ditch the traditional paper sign-in or punching clocks and invest in modern employee time and attendance management systems like Truein.
Truein is a cloud-based, hardware-less employee time-tracking system that ensures no overpayment. It can track workers in the manufacturing unit using its geofencing and GPS tracking features. It also allows managers to reduce the time spend on shift scheduling by allowing them to schedule the shift of employees in advance.
2. Keep overtime to a minimum
Overtime is a significant revenue killer for manufacturing companies. If you rely on a small number of workers, you will pay some workers overtime which is almost twice their regular wages. Also, other workers will remain under-utilized. Truein can help with overtime calculation and shift scheduling such that work is proportionately among the workers and overtime is minimized.
3. Train your staff
Proper training is essential to keep productivity high at any manufacturing unit. Better-trained workers work more efficiently, increasing output and lowering labor costs.
This guide will help you understand how to calculate labor costs in manufacturing. It is essential to check the labor cost to keep the business profitable, employees satisfied, and revenues flowing in.