22 Jun 22 / Blog

Understanding Labour Costs and How to Reduce them

Labour costs are generally the biggest costs for any business. That means it is important to consistently review your labour cost percentage and explore ways to reduce it, while not reducing productivity or morale.

What are the main costs of the business?

Although different businesses have different costs associated with them, the main operating expenses of most businesses include:

  • Rent
  • Equipment
  • Labour cost
  • Phone and utilities
  • Inventory
  • Fixtures
  • Licenses and tax deposits
  • Marketing budgets
  • Insurance
  • Professional services, such as accountants and lawyers.

Understanding Labour Costs and How to Manage Them

What Is Labour Cost?

The labour cost definition is the total expenditure that employers attain for the employment of their employees.

What are examples of labour costs?

Examples of labour costs include the salary paid to the sales director of the company, the hourly wages earned by an employee in human resources, or the hourly wages of an assembly line worker. Whether employees are on minimum wage or higher, they all contribute to the labour cost of the business.

Other examples include hourly wages, salaries, overtime costs, overtime hours, employee benefits package, employee compensation, health care, sick days and more.

Direct and Indirect Costs of Labour: The Difference

Direct labour cost: This includes wages paid to employees that produce the product. For example, employees that are working on the assembly line.

Indirect labour cost: This includes fixed costs or overhead expenses that the business have, such as rent for the premises. Indirect labour costs also include other expenses that are not directly linked to the production of a specific product.

For example, wages paid to employees that maintain factory equipment. This is known as support labour.

How to calculate the labour cost

Labour cost can be calculated as a percentage of sales, or as a percentage of total operating costs. The labour cost percentage formula shows you how much is as follows.

Labour Cost Percentage Formula

Labour cost percentage can be calculated as a percentage of total operating costs. To calculate labour cost percentage, divide labour cost by the total operating cost, then multiplying this figure by 100. (Total Labour cost/ total operating costs) x 100.

Labour cost percentage can also be calculated as a percentage of sales, by dividing total labour cost by the sales, then multiplying this figure by 100. (Total Labour cost/ total sales) x 100.

For example, if labour is costing €9000 per month and total operating costs rate €15000 per month. To calculate labour cost percentage, you must divide €9000 by €15000, which is 0.6. Then multiply 0.6 by 100 to receive 60%. This is the labour cost percentage for this business.

What is a good labour cost percentage?

Labour is often one of the highest expenses for businesses. For a typical restaurant, direct labour costs will make up about 30% of revenue. Each industry has different labour-to-cost ratios, and each industry has very different ideas about what a “good” labour-to-cost ratio is vs. a poor one is. However, the typical range for any industry is 15% to 30%.

How can I lower labour costs?

There are many ways businesses can lower their labour cost. Some of the common methods used include providing structured employee schedules to reduce the need for overtime, reducing employee turnover and incentive programs.

One method is to provide employees with predictable work schedules. This helps minimise the amount of overtime your employees will be working as their schedules are planned out.

Optimising schedules will also help with this and will allow you to gain a better understanding of your business trends, such as what are you busiest days/times. TnA Wizard is a time and attendance app that allows your team to manage their holidays and schedules.

Reducing employee turnover is a key long-term strategy to achieve a lower labour cost. It’s a lot more expensive to replace an employee than to retain great employees.

Incentivising performances, such as bonuses, is another great way to reduce variable labour costs. Bonus plans should be based on measurable performance metrics. Likewise, commission plans should be based on meeting key sales metrics.

When your employees are at their most productive, sales will likely be increased, leading to greater profit margins and greater employee morale.

How to Lower Labour Costs in Restaurants?

You can apply all of the methods previously mentioned to lower your restaurant labour costs. Some other commonly used methods to lower your restaurant’s labour cost include cross-training team members, so they can develop the necessary skills to perform more tasks and be more efficient. Employ part-time staff, as these employees are often ‘less-skilled’ and can be hired on lower hourly rates.

Some longer-term methods of reducing your restaurant labour cost include investing in your hiring process and investing in software or systems that can automate certain processes. Whether it’s outsourcing it to a recruitment company or not, investing in your hiring will result in better candidates receiving the job vacancy.

If your restaurant spends more time, money, and resources on finding the best candidate for the job, the return on investment should decrease your restaurant’s labour cost percentage.

Access Procure Wizard is a purchase to pay software system that empowers your team with a full kitchen management system that gives them full visibility over menus, dishes, stock, allergens, and nutritional information. It allows operators to get control of their food costs, reduce waste, capture credits, and save on admin time. This system will help reduce your restaurant costs by 10%.

Cost of Labor

Work with Fewer Resources and Smaller Budgets

Reducing resources and budgets isn’t as negative as you may think. If there is unnecessary baggage in your business, it’s important to make changes. Sometimes cutting back on budgets and getting rid of unnecessary resources can be an easy way to lower the cost of labour.

Increase insight into payroll costs

Being efficient with your payroll and overtime structure is important for businesses. Automating your time and payroll system will help you business to pay employees accurately. TnA Wizard is a great tool that will allow your team to do this and more.

Counteract rising labour costs with workplace efficiencies

Human resources can implement helpful workplace efficiency practises that can reduce the spending of the company on labour. In some workplaces, ‘buddy punching’ is common among employees. This is the process of one employee clocking in or out for another employee to hide the latter’s absence or tardiness.

It’s important for HR to eliminate buddy punching or any other methods that results in time theft. There are many other methods that HR can implement, but it’s important to be creative when finding a solution and making sure you find one that aligns with the goals and structure of your business model.

Bottom Line

Increasing your business bottom line is always one of the main goals, for any business in any industry. As previously mentioned with Procure Wizard, it cuts expenses in your business by 10% on average. This results in a gross profit increase in the range of 3-5%.

FAQ

What industry has the highest labour cost?

The industries with the highest average labour costs per hour are the Financial, Real Estate and Insurance sectors according to the CSO, which published the following labour statistics. Labour cost percentage by industry varies based on a number of factors.

What is the industry average for labour costs?

The average cost of labour varies across different locations and industries. The average hourly total costs of labour were €29.48 in the fourth quarter of 2021, an increase of 5.0% from the value of €28.07 one year previously and an increase of 4.6% from €28.19 in 2019.

What percent of manufacturing costs are labour?

Labour costs make up a large percentage of manufacturing costs. Manufacturing costs can be broken up into 3 categories: materials, overheads, and labour costs. Labour costs as a percentage of manufacturing costs is difficult to estimate as it will vary across different companies, locations, and industries. However, labour usually holds a higher percentage of manufacturing expenses than materials and overheads do.

What is the average cost of running a business?

The average cost of running a business varies for almost every business and depends on a number of factors: number of employees, size of the business, rent, overheads, labour costs and many more.

According to an article by Toast, the overall average cost to open a restaurant is between $100 and $800 per square foot. This price range is applicable to the United States but uses the same varying factors such as location, concepts, materials, size, and equipment.