How To Calculate Labor Cost Percentage

Imagine finding hidden profits in your current operations that unlock growth without any kind of extra investment. This is an added advantage for business owners who know how to manage labor cost percentages effectively.

Labor represents the largest expenditure in most businesses, swallowing 35% or more of the total revenue.

This guide focuses on how to calculate labor cost percentage & calculation of labor costs. So, let’s get started with it.

What is Labor Cost?

Labor cost is the amount which is required to pay for labor to run your organization. When most people think of labor costs, they think of wages. Labor costs encompass more than wages.

Labor cost includes:

Social Security Tax: Employers should contribute to Social Security, a mandatory federal program.

Benefits: This can include health insurance and retirement plans that can contribute to an employee’s total compensation.

PTO: Paid time off, holidays, or illness that represents a cost to the company.

Equipment and Training: Not a direct part of labor costs, investing in employee training and equipment can also be considered while calculating total labor investment.

Why Does Labor Cost Percentage Matters?

How to calculate labor cost percentage, and why does it matter? Let’s see why:

Improves profitability: If labor cost optimization is too high, profit might shrink. Keeping an eye on labor cost percentage helps you balance wages with revenue.

Better budget planning: Knowing how much of your earnings goes into it makes it easier to allocate funds for rent and supplies.

Inefficiencies: Higher labor costs might indicate poor scheduling. 

Benchmark against industry standards: Each industry has an average labor costs percentage. Example:

• Restaurant: 25-35%
• Retail: 8-20%
• Service business: 30-40%

How to Calculate Labor Cost Percentage?

To calculate the labor cost percentage step by step, you can follow this guide:

Determine the Time Period: Decide whether to measure weekly, monthly, or yearly labor costs.

Calculate the Total Labor Cost:

Adding the expenses related to that time period. Example:

1. Wages: $25,000
2. Payroll taxes: $3,000
3. Benefits: $2,000
4. Overtime: $1,000

Total Labor Cost = $31,000

Calculate Total Revenue:

Find the total income your business has generated during the same time period.

For example: Total Revenue: $100,000

Apply the Formula:

Insert the numbers into the formula:

1. Formula: $31,000 / $100,000 * 100 
2. Labor Cost Percentage: 31%

Labor Cost Percentage Example:

Restaurant Labor Cost Percentage:

• Wages: $40,000
• Payroll taxes: $5,000
• Benefits: $3,000
• Overtime pay: $2,000

Total labor cost calculation = $50,000

Your monthly revenue is: $160,000

Now apply the formula:

• Labor Cost Percentage: $50,000 / 160,000 * 100
• Formula: 31.25%

This means that about 31 cents of each dollar earned goes into employee-related expenses.

Labor Cost vs Revenue

A lower ratio means an effective control of labor costs, though a higher ratio signal generates more revenue, which is being allocated to payroll, ultimately impacting the profitability.

Calculating the Lower Ratio:

Formula is: Labor Cost Percentage=(Total Revenue/Total Labor Cost)×100

Let’s say, for example: 

The labor cost is $80,000, and the revenue is $300,000, then the percentage will be (80,000 / 300,000) x 100 = 26.67%.

Labor Cost Percentage Industries

The following are the labor cost percentage industries in the United States:

• Public schools
• Hospitals
• IT consulting
• Colleges and universities
• Professional employer organizations
• Specialist doctors
• Software publishing
• Management consulting
• Medical group practice management
• Portfolio management and investment advice

Ready to simplify your payroll calculations? Use Stubbuilder’s online paycheck stub generator to instantly calculate your labor cost percentage—just enter your labor costs and revenue, and get accurate results in seconds.

FAQs

1) What should be included in the labor costs?

Labor costs include wages, overtime pay, payroll taxes, employee benefits and commission. This covers all the expenses directly related to your workforce.

2) How often should I calculate the labor cost percentage benchmark?

Most businesses calculate it monthly to monitor changes. However, restaurants and retail businesses often calculate it weekly because of their fluctuating sales and staffing needs.

3) Why is labor cost percentage important?

It helps you manage profits, avoid overspending on labor, improve employee scheduling, and compare your costs with industry standards.

4) What happens if my labor cost percentage is high?

A high percentage can show that you have too many staff, are not using resources well, or are relying too much on overtime. This situation can lower profits and put a lot of pressure on your business’s finances.

Key Takeaways

A lower percentage doesn’t always mean better. It’s about finding balance. For example, a restaurant with excellent service may choose to maintain a slightly higher labor cost percentage to guarantee customer satisfaction.

By using the formula:

“Labor Cost Percentage = (Total Labor Cost ÷ Total Revenue) × 100”

You can quickly determine how much of your income goes toward paying employees.