How to Calculate Labor Costs in Construction: A Guide for Managers

Category: Construction | By ClockShark | 7 minute read | Updated May 28, 2024
How to Calculate Labor Costs in Construction: A Guide for Managers

Budgeting even simple construction projects can be a headache for anyone. It’s essential to keep projects on time and on budget; a large part of that task is due to the labor force. Labor costs in construction account for 20% to 40% of a standard project, but that number can reach as high as 60%, depending on the budget and additional costs. As you can see, it’s a big piece of the pie! 

So, it’s important to understand how to calculate labor cost in construction and the factors that contribute to accurate costs that can balloon a budget.

The Importance of Accurate Labor Costing

With the high percentage that labor costs account for, it’s easy to see why construction labor costs are a significant aspect of determining a project's overall expenses and ultimate success. The ability to accurately calculate labor costs for construction projects reflects not only on the budget but a thorough knowledge and planning of all aspects of a project. 

Contractors and project managers must calculate labor costs accurately to ensure profitability and project success!

In this article, we will explore the steps to calculate labor costs in construction, including understanding the types of costs, the factors of gross pay vs. actual cost, differentiating between direct and indirect labor and implementing strategies to lower labor costs and effectively manage your crew. 

What is Construction Labor Costing?

First, we’ll define labor costs and explain why an initial pay-per-hour rate doesn’t accurately reflect a worker's total cost.

Labor cost refers to the overall expense paid to workers involved in construction projects. This includes not just the team on the ground but everyone involved in making the project move forward: office workers, administrators, project managers, accountants, etc. 

It includes wages, taxes and benefits, making it a critical factor to consider when calculating and managing your business's finances and the estimated construction project cost. When finding out how to calculate labor costs in construction, all of these factors will be accounted for in the final figure. We’ll cover more of these costs later.

As with all aspects of your cash flow, you need to clearly understand what you’re spending versus what you’re bringing in. If you don’t know your construction labor costs, you risk underbidding jobs and/or under- or over-paying workers. 

Comprehensive Steps on How to Calculate Labor Costs

These calculations help you determine how much you need to allocate in your budget for labor expenses. Understanding labor costs is essential for accurately forecasting and managing your business's financial health.

When using a labor cost formula in construction, you need to understand the different types of payments associated with it. Most labor costs are either direct or indirect. Some of these costs may be variable, while others may be fixed.

For example, the cost of labor to run machinery is variable based on how much you use it. You can increase or decrease variable labor costs by increasing or decreasing the use of that machine. Conversely, fixed labor costs might include set fees for long-term contracts, such as scheduled maintenance for the machine.

1. Assessing Gross Pay: The Foundation of Labor Costing

The best place to start when working out how to calculate labor costs in construction is gross pay. This is taking the base rate of a team member to give yourself the foundation and baseline for other calculations and additions.

The base rate of labor costs is the amount each employee is paid per hour. If you have a small crew of a laborer, a framer, and a team lead, you will calculate their collective hourly pay rate as your base rate for having that team on a job.

For example, if the laborer makes $15 an hour, the framer makes $25, and the team lead makes $40, your total base rate for one day will be $80 for each hour worked per day.

Laborer: $15

Framer: $25

Lead: $40

Base rate = $80 per hour

 2. Determining Actual Work Hours: Accuracy in Tracking

It would be nice and easy to stop at gross pay, but every business knows that the costs don’t stop there. When looking at how to calculate labor cost in construction, you need to consider the actual work hours worked by a team member. 

One effective strategy for accounting for accurate labor costs is implementing time clock regulations, such as check-in and check-out policies, time-tracking software and features such as geofencing. 

With effective time-tracking processes and tools, businesses can avoid overpaying for idle time or unauthorized breaks by accurately tracking employee work hours. Time-tracking tools can provide valuable employee attendance and productivity data, enabling construction businesses to make informed decisions to optimize workforce efficiency.

As it goes with any project and progression, the more you know, the better.

3. Analyzing Annual Costs Per Employee: Beyond the Hourly Rate

Construction labor burden includes more than your hourly base rate. You have to consider the extra you pay for things like:

  • Insurance: fluctuates based on projects
  • Taxes: FICA, Social Security, Medicare etc.
  • Benefits: such as PTO and sick days
  • Meals: provided meals or subsidized meals
  • Supplies: for example, tools, equipment, and devices
  • Training: such safety training and new protocols

Want an easy way to calculate labor burden? Check out ClockShark’s Labor Burden calculator!

4. Total Annual Payroll Cost: Payroll and Benefits

While each company is unique, and perhaps you don’t offer the same benefits, there are still things to consider. 

For example, do your employees drive company vehicles home? Do they use your tools or their own? Do you provide crew members with company phones?

All these things would contribute to the amount you’re paying to have that team member working for you and reflect accurate results when calculating labor costs in construction.

Payroll Taxes

Ahh, taxes. Not paying for these is definitely more trouble than it’s worth!

Taxes include:

  • FICA taxes (7.65%), of which Social Security is 6.2% and Medicare is 1.45%
  • FUTA taxes (standard rate of 6%, but exceptions apply)
  • State unemployment taxes
  • Local unemployment taxes 

Employee Benefits

Depending on the project and your company, different benefits might be on offer that affect accurate labor cost.

These include:

  • Health insurance
  • Additional insurance, such as dental, life, or disability
  • Retirement plans
  • Paid time off (sick and vacation days) 
  • Meals at work
  • Education and training 

Other Possible Expenses

  • Overtime pay
  • Workers’ compensation insurance
  • Work supplies

We’ll break down some of these costs in greater detail later in the article. 

5. Calculating Labor Costs in a Real-World Scenario: Calculation Example

To illustrate some of these factors, we’ll use our crew member Eddie as an example of how to calculate labor costs in construction. 

Before calculating your labor costs, you must calculate your base rate and factor in your other direct and indirect costs. For that, you will need to use an indirect and direct labor cost formula. Using the examples above, let’s demonstrate how to calculate labor cost in construction with a robust example.

Our hypothetical employee, Eddie, is the star of our calculations. Eddie is an hourly, non-exempt employee, who works full-time in a construction company in California with more than 26 employees. He gets $22 an hour.

1. Gross Pay

The first thing you want to do is figure out Eddie’s gross pay.  Here is the formula:

Gross pay = gross hourly rate x number of hours worked for a pay period

Now to calculate Eddie’s gross pay per year. The total hours that Eddie is supposed to work for the period of one year are:

Total number of hours per year = 40 hours per week x 52 weeks = 2080 hours

This means his gross pay per year is: 

 $22 x 2080 hours = $45,760

2. Figure Out the Actual Worked Hours

The total work hours per year are 2080. This is a standard base rate. However, every employee needs to take days off from time to time or face emergencies that interfere with regular hours.

For this example, Eddie missed 12 days in the year. Here is how to calculate hours not worked:

Hours not worked = 12 days x 8 hours = 96 hours

Then you can easily get the net hours worked:

Actual worked hours = total number of hours per year - hours not worked

This would mean, in this case:

2080 hours - 96 hours = 1984 hours 

Eddie's actual work hours for a year are 1984 hours. This will be a rough estimate for most workers, but a worker will rarely work every scheduled day for a year. 

3. Determine All Annual Costs Per Employee

Next, you must consider all related expenses you owe Eddie, such as taxes and healthcare. These expenses are on top of his gross pay. It’s essential to understand gross pay based on the base wage as several additional costs are percentages of that wage. Accurate costing for gross pay results in accurate percentages in further calculations. 

Only after you calculate these factors can you get the actual labor cost per hour for a particular employee or the true cost per hour. 

In Eddie’s case, here is the breakdown of additional labor costs:

  • $3,339.07 annual taxes (6.2% Social Security is $2706.18, 1.45% Medicare is $632.90, 0.6% FUTA on the first $7,000 is $42, and California state unemployment insurance is 3.4% on the first $7,000, which equals $238   
  • $3,100 health insurance
  • $2,000 benefits
  • $900 overtime 
  • $500 meals

Thus, the extra annual cost you must pay for having Eddie as an employee is $10,119.07.

4. Calculate the Total Annual Payroll Cost

You are now ready to determine Eddie's actual annual payroll cost, also known as the ‘total labor cost.’ 

To achieve this:

Gross pay + additional annual costs = Annual Payroll Cost

In this example, the amount in this example is:

$45,760 + $10,119.07 = $55,879.07

This is the total annual cost of Eddie’s work for the year. 

5. Calculate the Hourly Labor Cost

Now, you can figure out Eddie’s true labor cost per hour with the annual payroll cost.

His hourly labor rate (wage) is $22. Now, we’ll see what the accurate hourly labor cost comes to. 

To achieve this:

Annual payroll cost / actual hours worked = hourly labor cost.

For Eddie, calculations come up to:

$55,879.07 / 1984 hours = $28.16 per hour

Ta-da! Now you know the actual hourly labor cost for Eddie. When figuring out how to calculate labor cost in construction, all factors are considered in this process and give your business accurate costing for each worker. 

Direct vs. Indirect Labor

To delve deeper into how to calculate labor cost in construction, it's vital to understand the difference between direct and indirect labor.  We covered this briefly to highlight the need for accurate costing in the labor budget and the kinds of team wages that may be missed at first.

Direct Labor: It refers to the employees directly involved in producing goods or providing services. 

Direct labor costs are relatively straightforward to calculate. Consider the number of hours crew members work and their corresponding wage rates.

For example, if a construction company has five employees working on a specific project, the direct labor cost would be the sum of their hours worked multiplied by their respective hourly pay rates.

Indirect Labor: This consists of employees who support the production process but do not directly contribute to the end product or service.

Indirect labor costs, however, are the costs that are not directly involved in a construction project. These costs include salaries of on-site contractors and project managers, for example. While these employees don't directly contribute to production, they play a crucial role in keeping the business running smoothly. 

Breaking Down Additional Costs

Direct vs. indirect labor costs are similar to direct vs. indirect construction costs. Labor simply focuses on the employee side of costing, whereas the latter focuses on all costs.

The best way to define the differences between direct and indirect labor costs in construction is that direct costs are the expenses specific to a particular project, and indirect costs are whatever expenses are left. Indirect costs are less defined and more variable like overhead, vehicles, and equipment; and these variables, while a smaller overall cost, can have knock-on ramifications if not accounted for.

So, let's cover some additional costs and the importance of their inclusion in any construction project budget.

Travel Costs

These are any expenses associated with a team member’s travel. This includes work cars, rental cars, airfares, meals and hotels/lodging. In construction businesses, employees may need to travel to different cities or states. Even travel outside of a regular work area can incur these costs.

Overtime Costs

These costs in construction can account for plenty of unaccounted-for hours. Overtime costs are the pay for any crew member who works longer than their standard work schedule. Unexpected delays or tight deadlines may necessitate OT costs, and they usually can’t be avoided. 

Proper planning can mitigate the worst of this but sometimes delays just happen.

Subcontractor Costs

These are any costs associated with hiring subcontractors to complete a specific part of a construction job/project, usually for specialized work your usual crew doesn’t handle. Contracts depend on the length of the project and how often they’re needed and include equipment, materials, labor and insurance. Projects/businesses develop a bidding process: advertise the need and subs bid to fill the role.

Training Costs

For a project to run smoothly, you need a skilled crew! Training costs can cover necessary safety training, equipment handling, project management and other skills. It’s important to keep your team up-to-date with the necessary skills and provide job progression and education opportunities.

Union Costs

These costs include employing unionized workers, such as union dues and benefits. Due to a union's collective bargaining nature, businesses can save costs by negotiating these terms with the union.

Key Challenges and Solutions in Labor Cost Calculation

As you can see, there’s a lot to consider when figuring out how to calculate labor cost in construction. There’s much more to it than the base rate offered to workers, and indirect costs make up a bulk of the overhead. 

So what are some of the challenges to a budget that also affect the accuracy of how to calculate labor cost in construction, and what are some of the things your business can do to improve it?

Staying on Budget

Estimating a complex construction project is challenging, but adherence to the budget is necessary for a project’s success. The reason it’s so important to understand how to calculate labor cost in construction is inaccurate costs come down to the small details.

Although overhead might not make up the majority of the budget as direct costs, it often needs a buffer for additional indirect costs that can balloon a budget. Projects won’t always stay on budget, but careful preparation is key. Anticipating possible risks and the probability will allow your budget to effectively prepare.

Ensuring Project Timeliness

Labor costs in construction are enough, even without delays. Project timeliness is essential to keep labor cost calculations accurate, as delays can cause overtime payments, work periods without effective productivity or crew schedules shifting to keep up with issues.

There’s no point paying laborers or subcontractors who can’t even begin their work due to a delay, so project progression is key!

Effective Resource Allocation

Calculating labor costs in construction highlights many of the additional costs that come with every individual worker. Using your existing worker pool as a resource for various tasks can be cost-effective. 

Cross-training employees is a valuable strategy to lower direct labor costs. By training team members to perform multiple tasks or roles, construction companies can optimize workforce utilization and reduce the need for additional labor. 

Identifying the potential within your current team is an investment that will likely yield significant returns in the long run. It’s good for your budget and can allow team members to access new skills and build their experience base no matter the project.

Boosting Productivity Through Accurate Costing

Accurate costing means all benefits and additional costs are covered in your budget, and this kind of security means happy crew members. The last thing employee’s want to worry about is if they’ll be paid on time, or at all, so by ensuring your budget reflects accurate job costs and accounts for any extra expenses, team members will work hard, trusting that they’ll be compensated.

Positive Work Culture and Environment

A high rate of absenteeism can significantly impact direct labor costs. When employees are absent, businesses may need to hire temporary workers or pay overtime to cover the workload. Implementing strategies that reduce absenteeism is essential to lowering direct labor costs.

Encouraging a positive work environment, offering incentives for good attendance, and implementing supportive policies such as flexible work arrangements can help reduce absenteeism. By addressing the root causes of absenteeism, construction businesses can minimize the impact on direct labor costs.

Compliance and Regulation

Compliance and regulation can seem like obstacles to some: things need to get done, but you have to wait for inspection or reports. But as any seasoned manager knows, transparent reporting and progress is key to staying on target.

Ensuring compliance and regulation during a construction project might have additional costs, but they save the project from unexpected budget blows in the future. Having to go back and redo non-compliant work when the project is near-completion is far more expensive and time-consuming than noticing and addressing issues as they occur.

Compliance and regulation are your friends when it comes to labor costs in construction!

Advanced Tools and Techniques for Labor Cost Calculation

Figuring out how to calculate labor cost in construction is down to the details, so how can you learn these details and get accurate insights on where your budget is going? Fortunately, technology and software have adapted to the needs of businesses and provide robust features to get the best from your crew.

Leveraging Time-Tracking App Software

With the right time-tracking software, you can get accurate, real-time hourly data about how much your worker’s rates are costing on the job. Gone is trawling through paperwork and calculations for insights: get timely updates from your phone or desktop and see how your team is progressing. 

The Role of Mobile Time-Tracking Apps

Time-tracking apps are available not only on desktops but also on cellphones as apps. These purpose-made apps are designed to make time-tracking easier for everyone, allowing workers to clock in and out on the go, post project notes and updates, and see schedules in real-time. 

Apps are an excellent tool to boost your team's productivity and accountability.

Utilizing Web Punch Clocks for Desk Employees

While field service teams can most benefit from the latest time-tracking software, desk employees can also benefit from the ease of these apps. Web punch clocks allow office workers to clock in and out, check their schedules and submit time-off requests from any desktop, streamlining team management in one place.

Kiosk Clocks for Team Performance Analysis

Kiosk clocks allow workers to punch in and out from one device, using their own unique PIN and facial recognition to ensure honest time-tracking. 

The use of time-tracking software means you can set up these kiosk clocks anywhere, on any device, making it a great middle-ground for construction projects and crews. This means you know when workers clocked in and time spent on the job for productivity insights and performance analysis.

GPS and Geofence Apps for Field Crew Efficiency

Time-tracking apps make the most of cellphone GPS capabilities with location-based tracking and scheduling. With GPS, get dynamic updates on where your field service team is and their movements during work hours. 

Time-tracking apps offer geofencing for automatic scheduling or accurate reports of when and where your employees clock in for jobs. Geofencing is a feature where your business can set job locations, and each of these locations is given an effective radius. When team members enter the radius, some apps allow time to start automatically. For manual starts, get insights into when your crew really clocked in for accurate costing. 

Enhancing Labor Cost Management in Construction

As you can see from our extensive article, accurately calculating labor cost in construction is vital to the health and success of a project. There are many challenges, but many more solutions and tools to assist your business to enhance your labor cost management. 

Utilizing the latest technology to boost your budget has many benefits, and all the features listed are available with ClockShark’s industry software. 

Labor cost can be wrangled with the right tools, so try a demo today!

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