Labor rate is not to be confused with labor costs, which refers to the sum of all labor rates in a specific timeframe. Labor costs are calculated by multiplying the labor rate by the number of hours each employee has worked for a given period.
Companies keep accurate tabs on their labor rate and make frequent comparisons to the revenue to prevent employee costs from hurting their bottom-line profits.
How Does Labor Rate Work?
The labor rate is a key figure calculated by finance and accounting departments to ascertain the direct and indirect prices companies pay for their employees' hourly wages. The direct and indirect prices refer to:
- Direct price – or direct cost of labor refers to the hourly employee rates. It includes company benefits directly connected to the product manufacturing or other services the company provides.
- Indirect price – or indirect cost of labor refers to the number of money companies allocate to employees who are not directly connected or involved in the product manufacturing or other types of services the company provides. These employees may be administrative employees or assistants.
Following that, the labor rate can be further fragmented into two separate costs – fixed and variable costs.
- Fixed costs – contracted costs that are predictable or reoccurring. Fixed costs may be fees for long-term contracts and commissions. For example, a contract with a third party hired to maintain or repair production machinery.
- Variable costs – costs that increase or decrease according to production demands or the present economic conditions. For example, the labor rate required to operate the machinery and equipment can vary depending on the present production levels.
How Is the Labor Rate Calculated?
Companies and enterprises track their labor rate as it can help them price their products or services and strengthen the company’s economic condition and revenue.
There are many methods to calculate the employee labor rate, from manual calculations with pen-and-paper spreadsheets to project management software that greatly automates how companies track their employee labor rate.
To manually calculate the labor rate of their employees, employers or managers usually conduct a simple labor rate formula: the hourly wage + all annual costs and taxes divided by the total amount of work hours.