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Labor Cost Definition and Formula | What Is Labor Cost?

January 20, 2021
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Scott
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For most businesses, the largest cost they endure is labor cost. And that’s certainly true for restaurants and foodservice businesses.

And labor cost percentage is a hugely important metric to pay attention to.

That’s because it speaks to your business’s ability to efficiently turn labor into profit. The better you do that, the better you are at your job. The better your business is at, well, conducting business. And the better leadership and investors think of your company.

Here’s what labor cost is and how to calculate it with a labor cost formula.

What Is Labor Cost: Labor Cost Definition

Labor cost is the total of wages, benefits, and payroll taxes paid to and for all employees. It’s divided into two categories: direct and indirect labor costs.

Direct labor costs are the wages paid to the employees that produce products or services. Indirect labor costs are costs that facilitate that production. The wage of a worker who maintains production equipment is a good example of an indirect labor cost.

How Much Does Labor Cost

Labor cost varies among industries. But it has some similarities that help businesses figure out how much labor costs.

Here’s what you have to factor in when calculating labor cost:

  • Wages
  • Payroll taxes
  • Overtime
  • Bonuses
  • Health care
  • Sick days
  • Vacation days
  • Insurance
  • Benefits
  • Meals
  • Supplies
  • Training
  • Public transportation stipends

Think about your expenses for everything listed above and you’ll get closer to figuring out how much labor costs.

Average Labor Cost

On average, labor costs make up about 68% of an employee’s annual wages. That’s why you can get a decent estimate of an employee’s labor cost by multiplying their total salary by .68. Employee benefits often account for almost 30% of overall labor costs.

But, strangely, restaurants are different.

Restaurant Labor Cost

Restaurant labor cost is one of the primary expenses in running a restaurant, along with overhead expenses. The amount a restaurant spends on labor affects many things. One of the most important is their prime cost, which is a metric ownership and investors look at to gauge a restaurant’s financial health.

Restaurant labor cost is hard to keep low and it ain’t going down. 60% of respondents to a 7Shifts survey of restaurant managers said their labor costs went up in 2019. And with the rising cost of living and an increase in minimum wage for tipped employees on the horizon? Labor costs for 2021 and beyond are slated to increase.

That means restaurant and bar manager duties, going forward, will always contend with rising labor costs. And using historical sales data from a bar management software like BinWise is how companies use forecasting data to cut labor hours (and costs).

Average Labor Cost for Restaurant

Restaurant labor cost is typically 30 to 35% of a restaurant’s total revenue. And most restaurants shoot for 20 to 30% labor cost. It’s not easy getting to your goal labor cost.

The remaining operating costs of a restaurant are food cost (which include your beverage program) and rent/overhead.

Is Labor a Fixed Cost?

Oh, you wish it was that easy. But labor can be a fixed cost or a variable cost. 

Fixed costs do not vary in relation to sales. Think business insurance or rent. Variable costs do vary in relation to sales. Think food costs, liquor cost, or COGS.

Fixed labor costs are, then, the labor you will pay no matter how much revenue you drive. Your cleaning crew, complete with periodic restaurant hood cleaning and everything else. The skeleton crew you need to open the place up. Etcetera. 

Variable labor costs are the extra servers you need for a busy Friday dinner shift. Or the extra line cook you need because of that big private party.

How to Calculate Labor Cost: Labor Cost Formula

There are two primary ways of calculating labor cost. You can do it as a percentage of sales or as a percentage of total operating cost.

Labor Cost Percentage Formula

Here’s the labor cost percentage formula for calculating labor cost as a percentage of sales:

Labor Cost Percentage = (Total Labor Cost / Total Sales) x 100

And here’s the labor cost percentage formula for calculating labor cost as a percentage of total operating costs:

Labor Cost Percentage = (Total Labor Cost / Total Operating Costs) x 100

Now let’s look into how to use the formulas.

How to Calculate Labor Cost Percentage of Sales

To calculate labor cost as a percentage of sales, first tally up your restaurant’s total labor cost. This is all the money spent on direct and indirect labor costs over whatever period of time you’re measuring.

Next, pull your restaurant’s total revenue from your POS or restaurant or bar inventory software. This is your bottom line. All your pre-tax and pre-deduction earnings. 

Divide the labor cost by the annual revenue and multiply by 100. This number will be your restaurant’s labor cost percentage of sales.

Imagine a restaurant with an annual labor cost of $84,000. Now let’s say total sales revenue for the year was $800,000.

Labor cost percentage = (84000 / 800000) x 100
Labor cost percentage = 10.5

10.5% of total sales? Wow, that’s pretty low.

How to Calculate Labor Cost Percentage of Total Operating Cost

You can also calculate labor cost percentage of total operating costs.

First, you’ll determine your restaurant’s labor cost, just as before. 

Then figure out your total operating costs. This includes revenue, but takes into account all food costs, beverage costs, rent, overhead, and marketing.

Divide labor cost by total operating cost and multiply by 100. This number is your restaurant’s labor cost percentage of total operating costs.

Let’s use the total labor cost figure of $7,000 per month. And let’s say total operating costs are $12,000 per month.

Labor cost percentage = (7000 / 12000) x 100
Labor cost percentage = 58.3

58.3% of total operating costs? Wow, that’s pretty high.

Labor Cost Calculator

We dug through the internet to find the three most faithful labor cost calculators out there. 

Peep these:

Omni Calculator

TSheets

The above calculators are useful in calculating your total labor cost itself. But what if you need to calculate labor cost as a percentage of sales or operating costs? Just use the formulas above and the calculator on your computer.

Labor Cost as a Percentage by Industry

Here’s an interesting look at the labor costs by industry from 2018 to 2019. The numbers provided below aren’t the actual labor cost percentages of each industry. They’re a ranking of which industry has the highest labor cost percentage change year-over-year. While the dataset is limited, it provides a useful glimpse into long-term labor cost trends at an industry level. All data from the U.S. Bureau of Labor Statistics

Industry Percentage Change
Trucking, local 18.4
Couriers and messengers 13.2
Postal service 11.4
Truck, trailer, and RV rental and leasing 10.4
Specialized freight trucking 10.2
Trucking, long distance 9.8
Water and sewage 8.1
Medical and diagnostics 6.9
Travel services 6.4
Newspaper publishers 5.9
Cable and subcription programming 5.4
Power generation and supply 5.2
Amusement parks and arcades 4.6
Accounting and bookeeping 4.5
Radio and television broadcasting 4.4
Restaurants and other eating places 3.9
Air transportation 3.5
Engineering services 3.4
Drycleaning and laundry services 3.4
Natural gas distribution 3.2
Warehousing and storage 2.6
Wire telecommunications carriers 2.1
Commercial banking 0.8
Automotive repair and maintenance 0.8
Wireless telecommunications carriers -0.05
Software publishers -1.1
Line-haul railroads -1.9
Gambling industries -5.3
Periodical publishers -6.7

Of interest, five industries had their labor cost shrink because of hourly compensation growing at a slower rate than productivity. Those are the last five industries with negative numbers.

How to Lower Labor Cost in a Restaurant

It obviously behooves businesses to lower their labor costs. To the extent that employee satisfaction or quality of life isn’t sacrificed.

Here are some tried-and-true ways businesses can chip away at ever-growing labor costs:

  • Stay vigilant on every employee’s hours worked to spot any unnecessary overtime. Some states have particularly expensive overtime laws requiring double-time pay for hours worked over 40. 
  • Pay employees when they’re scheduled to start, and not when they clock in. Those 5, 10, or 15 minutes add up.
  • Offer non-monetary bonuses to reduce missed shifts. The reason missed shifts hurt labor cost is that it catapults another employee (the one who will cover the missing employee’s shift) toward overtime.
  • In the same line, cross-train employees. If a server can hop behind the bar to make drinks when the service bartender calls out, you may not need to add extra payroll.
  • Look over historical sales and traffic and cut hours on the nights that are typically slow. This is easy to do with bar inventory software like BinWise Pro.
  • Try combining vacation and sick leave in one PTO bucket. If you provide two weeks of paid vacation and two weeks of sick leave, try three weeks of both combined.
  • Hire the right restaurant and bar staff. If you get the right people the first time around, it’s great for labor cost.

A lot of reducing labor costs is about optimizing bar management. The better you are at your job, the better your employees are at theirs. That means higher productivity, fewer days off, and better execution.

Using a beverage inventory management system like BinWise helps streamline almost every aspect of stocking and selling alcohol. It gives you reams of data to analyze to make sure you’re scheduling only the employees you need to.

Invest in BinWise is an investment in your employees. And the payoff for bars and restaurants across the country has been outstanding.

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