The construction industry is more competitive than ever, so accurate estimates are critical. Labor is usually among the largest costs associated with any project; even small errors in this part of an estimate can turn a seemingly profitable job into a potential loser.

Yet knowing your payroll costs alone isn’t enough. You’ve got to know your true labor costs. And how do you determine that? By using a metric called labor burden rate.

Accounting for everything

Strictly defined, labor burden rate for an employee or class of employees is total indirect labor costs as a percentage of direct labor costs. (For the purposes of this calculation, we’ll consider payroll to be direct labor costs.)

Typically, the rate ranges from 30% to 40%, though it can be even higher for union contractors. For example, say you pay an employee $30 per hour. If your labor burden rate is 40%, then your true labor cost for that employee would be $30 + (40% x $30) = $42 per hour.

To accurately calculate labor burden rate, you must add the various indirect costs you incur in connection with an employee or class of employees. These include but aren’t limited to:

State and federal payroll taxes. Included here are taxes levied under the Federal Insurance Contributions Act (FICA), Social Security and Medicare, as well as unemployment taxes. The employer’s share of FICA taxes is 6.2% for Social Security and 1.45% for Medicare, and the current federal unemployment tax rate is 6%.

Fringe benefits. It’s critical to identify all that your construction company sponsors. Common examples include medical, dental and vision insurance; life and disability insurance; matching retirement plan contributions; bonuses and profit-sharing; and tuition reimbursement or student loan debt assistance.

Commercial insurance. These costs include the premiums you pay for policies covering things such as workers’ compensation, general liability, professional liability, vehicles and pollution.

Training. If your construction business provides training of any kind, including safety training, you need to track its costs closely and factor them into your labor burden rate.

Job-related clothing, safety gear and tools. Does your construction company provide any of these things to workers? If so, you must itemize their costs and apply them to labor burden rate.

Company-provided vehicles, cellphones and tablets. Many construction businesses maintain a fleet of vehicles, and some provide employees with mobile devices. Costs associated with these factor into labor burden rate as well.

Nonproductive time and activities

Along with identifying direct and indirect costs associated with employees, you need to account for “nonproductive” time and activities. This is essentially paid time off, such as vacations, sick days and holidays, as well as activities not performed on a jobsite, such as attending specialized training or in-office meetings.

Why? Because the hourly pay rate you use in estimates must sufficiently cover the costs of employees’ productive time and their nonproductive time.

Suppose, for example, that Joe, a construction worker, earns $30 per hour. Assuming he’s paid for 40 hours per week, 52 weeks a year, for a total of 2,080 hours, his annual salary is $62,400. Next assume that, after accounting for taxes, benefits and other indirect costs, his employer’s total cost associated with Joe is $78,000 per year or $37.50 per hour ($78,000/2,080).

But Joe doesn’t spend every one of those 2,080 hours working on “chargeable” construction projects. Let’s assume he’s paid for a total of 200 hours per year for nonproductive time and activities, such as vacation, sick days, holidays, training and company meetings. That means Joe’s total productive — that is, chargeable — time is 1,880 hours per year. Thus, to ensure that it charges enough to cover Joe’s annual costs, his employer should use a labor rate equal to $78,000/1,880, or approximately $41.50 per hour.

In this example, Joe’s labor burden rate is $11.50/30, or 38%. The good news is it’s usually unnecessary to calculate labor burden rates for every employee. In most cases, you can perform the calculation for each class of employees.

Key performance indicator

To help ensure accuracy, you’ll need to recalculate your labor burden rates frequently — at least every six months. This is, of course, to account for pay rate fluctuations as well as changes to the costs of benefits, insurance and other contributing factors.

The value of calculating labor burden rates goes beyond better estimates. This critical metric can also serve as a key performance indicator to help with strategic decisions. For instance, if your rates are too high, you may have to seriously consider cost cutting. If they’re too low, you may be able to add benefits or upgrade insurance. Your CPA can offer expertise and assistance with all the number crunching.

Tips for reducing workers’ compensation insurance costs

Although payroll is undoubtedly a huge factor in calculating labor burden rate (see main article), don’t underestimate the impact of workers’ compensation insurance costs. These can be substantial for construction companies. Here are some tips for reducing workers’ comp costs:

• Properly classify employees; the more who are deemed to be in high-risk jobs, the higher your premiums will be.
• Double-check the accuracy of your experience modification rate; as you may know, this is the metric that your insurer uses to set your premiums based on your construction company’s loss history.
• Develop a solid safety program; the best way to reduce workers’ comp costs is to avoid accidents and injuries.
• Establish a return-to-work program; such programs gradually reintegrate injured employees into the workforce, typically through part-time or less physically demanding work, to minimize the amount of time they’re off the job and reduce workers’ comp claims.

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