Managing labour costs is essential for small businesses and startups, as it's often one of the largest expenses. Understanding these costs can help improve budgeting, pricing, and overall profitability. In this guide, we’ll break down what labour cost is, its different types, and how to calculate it.

What is Labour Cost?

Labour cost refers to the total expenses a business incurs for employing staff. This includes more than just wages—employers need to account for benefits, taxes, overtime, and other overheads. Properly calculating labour costs is critical to ensure you're pricing your products or services accurately and maintaining a profitable business.

There are two main types of labour costs:

• Direct labour cost: Expenses tied directly to production, such as employees who make your products or provide your services.

• Indirect labour cost: Supportive roles that don’t directly contribute to production but are vital to running the business, like HR, accounting, or office management​.

Steps to Calculate Labour Costs

1. Calculate Gross Pay: For hourly employees, multiply their hours worked by their hourly wage. For salaried employees, divide their annual salary by the number of pay periods. For example, if an employee earns £30,000 per year, their gross weekly pay is about £576.90.

2. Account for Employer National Insurance Contributions (NICs): In the UK, employers must contribute to National Insurance for each employee earning over £12,570 per year. The employer NIC rate is generally 13.8% of earnings above this threshold​. For instance, on a £30,000 salary, you would pay NICs on £17,430 (30,000 - 12,570), amounting to about £2,406.34 annually.

3. Include Pension Contributions: If you're auto-enrolling employees into a pension scheme, employers are required to contribute at least 3% of qualifying earnings (earnings between £6,240 and £50,270 in 2024)​. For an employee making £30,000, pension contributions would be approximately £712.80 annually.

4. Factor in Holiday Pay, Sick Pay, and Other Benefits: The UK requires employers to provide at least 28 days of paid holiday (including bank holidays) per year for full-time workers. Add this to any additional perks like sick pay, bonuses, and other benefits like private health insurance or flexible working allowances​.

5. Training and Recruitment Costs: Consider the cost of training, recruitment, and onboarding, which can be substantial, particularly for specialised roles. These costs might include job advertisements, recruiter fees, and training programmes​.

6. Calculate Total Labour Cost: Once you've calculated gross pay, added employer NICs, pension contributions, and any other benefits, you have your total labour cost. For example:

   • Gross salary: £30,000

   • Employer NICs: £2,406

   • Pension contributions: £712.80

   • Other benefits and costs: £1,500 (estimated)

   Total labour cost: £34,618.80 per year.

7. Hourly Labour Cost: To get an hourly figure, divide the total labour cost by the number of hours worked in a year. For a full-time employee (37.5 hours per week, 52 weeks a year), that’s about 1,950 hours. So, £34,618.80 ÷ 1,950 = £17.75 per hour​.

Managing and Optimizing Labour Costs

Here are some ways to manage and optimize labour costs effectively:

• Track labour cost percentage: This shows labour costs as a percentage of total revenue. Ideally, businesses should aim to keep this under 30%, though it varies by industry​.

• Consider indirect costs: Make sure to account for overhead expenses like office space, utilities, and equipment, which are influenced by the number of employees​.

• Upskill employees: Investing in training can increase productivity, helping you get more value from your labour​.

By understanding and accurately calculating labour costs, small businesses can make informed decisions that improve profitability and long-term success.