Labor Cost Calculator

An employee costs more than their wage

Ask what an employee on ten an hour costs and most people say ten an hour. It is the number on the contract and it is not what the business pays.

Two things push it up. There are costs beyond the wage: employer taxes, insurance, benefits, the equipment they use. And there are hours you pay for and do not receive, because people take holiday and get ill.

This tool works out both and gives you the figure that matters, which is what an actually worked hour costs you.

On the numbers this page walks through, ten an hour turns out to be 12.60. Twenty six percent more than the contract says, and it is the 12.60 you have to recover when you price a job.

Nine fields

Three about the person:

1. Gross hours per week. Contracted hours, typically 40.
2. Pay Rate. The hourly wage.
3. Absent days per year. Holiday, sickness, any paid day not worked.

Five about everything else, all annual:

1. Taxes. Employer payroll taxes and contributions.
2. Insurance. Liability, workers compensation, health cover.
3. Benefits. Pension contributions, allowances, anything else provided.
4. Overtime. Expected overtime pay for the year.
5. Supplies. Equipment, tools, uniform, software.

And one about the business:

1. Total revenue. Used only to express labor as a percentage of what you take.

Enter zero rather than leaving fields blank where something does not apply, since the tool needs a number in each.

Four steps to the real number

Step one, hours paid for. Weekly hours multiplied by 52.

Step two, hours actually worked. Subtract absence, counted at 8 hours a day. This is the step most cost calculations skip entirely.

Step three, total annual cost. Gross pay plus all five additional cost lines.

Step four, the true hourly cost. Total annual cost divided by hours worked, not hours paid.

That last division is where the two effects combine. The numerator has grown because of the extra costs, and the denominator has shrunk because of absence. Both push the rate up.

The tool also divides the total annual cost by revenue to give labor as a percentage, which is the standard operating benchmark and gets its own section below.

One note on the absence conversion. It assumes an 8 hour day regardless of what you entered for weekly hours. If your standard day is not 8 hours, convert your absence into equivalent 8 hour days before entering it. Someone on a 37.5 hour week working 7.5 hour days should enter 20 days of absence as 18.75.

A ten an hour employee

Gross hours 40 a week, pay rate 10, absence 15 days. Annual costs: taxes 900, insurance 600, benefits 1,200, overtime 800, supplies 400. Revenue 80,000.

Now watch where the 2.60 of difference comes from, because the two causes are not the same size:

The additional costs are the larger effect at 1.99, and absence still adds 61 pence an hour on its own. Neither is visible anywhere on a payslip or an employment contract.

The hours you pay for and do not get

Fifteen absent days is 120 hours, which is under 6 percent of the year. It sounds negligible and it is not, because the cost does not go away when the person does.

You still pay the wage. You still pay the insurance, the benefits and the equipment. All of it now has to be recovered across fewer productive hours.

Every five days of absence adds roughly 25 pence to the hourly cost.

Two things to enter honestly here. Statutory holiday entitlement is absence, and it is the largest component in most countries. And unpaid absence should not go in, because you did not pay for those hours, so they do not need recovering.

Worth adding that this counts absence only. Paid time that is not productive, training, travel between jobs, waiting for materials, is real and does not appear here. A trade business where staff spend two hours a day driving has a true cost well above what this returns.

What goes in the additional costs boxes

Taxes means what the employer pays, not what is deducted from the employee. Employer social security, national insurance, unemployment contributions. Anything withheld from the employee's wage is already inside the gross pay and putting it here counts it twice.

Insurance covers employer liability, workers compensation, and the employer share of health cover.

Benefits covers pension contributions, allowances, subsidised meals, transport, anything provided on top of pay.

Overtime is the annual overtime bill. Note that this adds to cost without adding to the hours in the denominator, so heavy overtime raises the true hourly figure quite sharply. That is arguably the honest treatment, since overtime hours are usually paid at a premium.

Supplies is anything the person needs to do the job. Tools, uniform, a laptop, software licences, a phone.

Things that do not belong: rent and utilities, which are general overhead rather than the cost of one employee, and any cost that would continue if the role disappeared.

A useful rule for the boundary. Ask whether the cost would vanish if you did not employ this person. If yes, it goes in. If the business would carry it regardless, it does not.

Labor as a share of revenue

The last output divides total annual labor cost by revenue. Here it is 30.88 percent.

This is the standard operating benchmark in labor-heavy trades, and the useful ranges vary sharply by industry. Restaurants typically watch a figure in the region of a third. Professional services run much higher, since labor is essentially the whole product. Retail and distribution run lower, because most of the cost is in the goods.

Two cautions on the number this tool gives you.

It uses the cost of one employee against total revenue. So it is the share attributable to that person, not your overall labor ratio. To get the whole picture, sum the annual cost for every employee and divide that total by revenue.

And revenue should be net of returns and discounts, on the same basis you use everywhere else, or the percentage will read slightly low.

What makes it worth tracking is direction rather than level. A labor percentage creeping upward while revenue is flat means costs are outrunning what the business takes, and it is one of the earliest signals available.

Using the true rate to price work

This is where the number pays for itself.

If you quote jobs by the hour, the rate you charge has to recover the true cost, not the wage. Quoting on 10 when the real cost is 12.60 means every hour sold loses 2.60 before overhead, before profit, before anything.

The sequence:

1. Start at the true hourly cost, 12.60.
2. Add a share of overheads that are not in these boxes: premises, admin, insurance on the business itself.
3. Add the margin you need.
4. That is the minimum defensible charge-out rate.

The margin calculator handles that last step, and it is worth using rather than eyeballing, since adding 30 percent to your cost gives you a 23 percent margin rather than a 30 percent one.

Two other places the figure is directly useful. When you are deciding whether to hire, the annual payroll cost of 24,700 is the number to compare against the additional revenue the role would generate, not the 20,800 of wages. And when weighing a contractor's higher hourly rate against an employee's, this is the comparison that makes it fair, since a contractor's rate has no absence, no benefits and no employer taxes hidden behind it.

This is an estimate based on figures you supply rather than a payroll calculation, and nothing here is tax or employment advice.

Questions people ask

How is true hourly labor cost calculated?

Total annual cost, meaning gross pay plus taxes, insurance, benefits, overtime and supplies, divided by the hours actually worked after absence. On the example, 24,700 divided by 1,960 hours gives 12.60.

Why is it so much higher than the wage?

Two reasons combining. Additional costs raise the total, and absence reduces the hours across which it has to be recovered. On a 10 rate the result is 12.60, which is 26 percent above the contract.

Which taxes go in the taxes box?

Employer contributions only. Anything deducted from the employee's own pay is already inside the gross wage, so including it counts it twice.

Should I include holiday as absence?

Yes, if it is paid. Statutory holiday is usually the largest component. Unpaid leave should not be included, since you did not pay for those hours.

What if my working day is not 8 hours?

The absence conversion assumes 8 hour days. Convert first: 20 days of absence on a 7.5 hour day is 18.75 eight-hour equivalents.

Why does overtime raise the hourly cost?

Because it adds to the total cost without adding hours to the denominator. That reflects overtime usually being paid at a premium rate.

Is 30 percent labor cost good?

It depends entirely on the industry. Restaurants often watch a figure around a third, professional services run far higher, retail lower. Track your own direction rather than comparing across trades.

What should I charge per hour?

Start from the true cost, add a share of overheads not included here, then add your target margin. Charging the wage rate loses money on every hour sold.

References

The distinction between employer payroll taxes and amounts withheld from an employee's wages, and the treatment of wages, supplemental pay and employer contributions, follows the Internal Revenue Service's employer guidance. The treatment of employee compensation and related costs as deductible business expenses, and the boundary between costs attributable to producing goods or services and general overhead, follows IRS small business guidance. The relationship between a markup applied to cost and the resulting margin, used when converting a labor cost into a charge-out rate, follows guidance published by the US Chamber of Commerce.

1. Internal Revenue Service, Publication 15 (Circular E), Employer's Tax Guide. https://www.irs.gov/publications/p15
2. Internal Revenue Service, Publication 15-B, Employer's Tax Guide to Fringe Benefits. https://www.irs.gov/publications/p15b
3. Internal Revenue Service, Publication 334: Tax Guide for Small Business. https://www.irs.gov/publications/p334
4. US Chamber of Commerce, Pricing Markups Explained: Definition and Similar Terms. https://www.uschamber.com/co/start/strategy/what-are-pricing-markups