How to Calculate Labour Costs — (Part 3) What Makes up the Cost of Labour
It’s at this point in the discussion that someone inevitably raises the question of contract employees and their own variations. We’ll actually discuss that in a future article. I’ll explain why that is the worst mistake you can make in that article. But for the moment, you need to accept that my definitions are correct.
In fact, I’m going to drop the non-time Employee from the discussion. Why? Because they represent a variation of hourly using a base other than time. Or they represent a hybrid of salary and time. In any case, considering only salary and hourly will provide an example of all the possibilities.
So what are the costs involved in employing someone?
In the following discussion, I’m going to presume that you are charging your clients. In fact, I don’t need to make that distinction. However, doing so makes explanations easier. So for the moment I want you to imagine that your department bills other departments for work performed. Or that yours is an independent company which bills clients for work done.
There are ten sets of costs involved in any worker situation:
- Actual labour
- Non-productive labor
- Statutory Holidays labour
- Days off labor
- Vacation labour
- Employment taxes
- Worker overheads
- Company overheads
- Company profits
Actual labour cost is the rate of pay you give your employee for working for you for which you are receiving some form of return. In the case of a service industry (such as IT), this is the amount of time that you can charge a client for.
Strictly speaking, non-productive time is any time that you must pay your employee for but which you can’t charge to a customer. But for our purposes, this is going to be limited to time your employee works but which can’t be charged. For example, training time and meeting time typically can’t be charged to a particular client or project. However, you do need to pay for the time. After all, your employees don’t work for free. Typically, this type of time actually is valuable and productive it just can’t be charged to anyone outside your department.
But of course, no one works all the time. There are three other types of time which are typically paid by the company. These are often considered to be benefits. However, in fact, they are part of the basic cost of labour or their salary. For our purposes, we’re going to consider them individually and separately from benefits. The three types of non-working labour are for statutory holidays, sick days and time off, and vacation days.
Statutory holidays are paid days off for days like Christmas and New Year’s Day. In theory there are 9 days mandated in law in Ontario. However, virtually all companies provide a minimum of ten. Many provide 11. And some twelve. (Simcoe day, Easter Monday and Remembrance Day being the extra bank holidays). Some of these are, in fact, mandated for federally regulated companies such as banks.
In Ontario, all employees are guaranteed 2 weeks of vacation. However, as I’ll discuss later Ontario’s latest labour standards were a step backwards both with respect to the previous law and to other jurisdictions in Canada. Most employees in fact, continue to accrue additional weeks after five and ten years of employment. In addition, many experienced employees will negotiate extra weeks of vacation time.
Finally, sick days are often ignored. However, in Ontario employers are required to provide up to 10 sick days (called personal emergency leave days).
Benefits are those items purchased by the Employer on the employee’s behalf. Some of these costs will be taxable while other will not. In all cases however, the employee (or their designate) will be the beneficiary of the benefit. As well, any amounts paid by the Employee (called co-pay) are not included. Examples of these types of items are group insurance and drug and dental plans. However, items such as director’s insurance or key person insurance are not a benefit since the company is typically the beneficiary.
Unfortunately, whenever we employ someone the government imposes taxes. The employee pays some of these, like income tax. Many however are paid either by both or by the company. For example, the company matches the amount paid by the employee for CPP and EI. Actually, the company pays slightly more than the employee does. On the other hand, the company pays for both workers ‘ compensation insurance and OHIP. OHIP in fact, is a political football bouncing between company paid and co-paid. Additionally there are other costs which hiring a person imposes. Some of these such as recruiting costs are imposed on hiring. Others like severance are imposed on termination. Still others such as worker’s compensation are imposed during the lifetime of the employee.
Finally, employing someone requires us to spend other money. Some will be directly attributable to providing the services we’ve employed the worker for. These are worker overheads. They include such things as phone and a desk. A certain overlap exists between employment taxes and worker overheads. However, generally a cost that is related to employing the employee is an employment tax. A cost associated with providing support (e.g. equipment) to allow that employee to deliver value is a worker overhead.
In addition, there are other indirect costs which are assigned to the worker for accounting purposes. I’ve called these Company overheads. Items such as cleaning staff, supervision and company income taxes are examples. If your department is income producing then each employee will be expected to produce a certain level of profit.
Of course, to be useful, we normally talk in terms of rates. That is cost divided by some unit. In fact, in theory even total cost is actually being expressed in terms of some unit (typically a year). However, normally we use hours for labour rates. However, there are two different hours in use. We’ve hinted at it in our breakdown of costs. The first is working hours or overall hours worked. The second is productive hours. These are the hours that actually produce work and would be billable if your department billed for its services.
So what rates actually matter?
There are only four. They will be subject of our next article in the series.
- What is the difference between a contractor and an employee: Who gets paid for what
- How to Calculate Labor Costs — (Part 5) Five Deadly Myths
- How to Calculate Labour Costs — (Part 4) The Quick and Dirty Method
- How to Calculate Labour Costs — (Part 2) Who is Actually Working For Us
- How to Calculate Labour Costs – (Part 1) A Problem of Knowledge