Labor Cost Allocation — How to Better Track Your Dollars

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Whether you’re working in construction or technology, finance or manufacturing, every organization needs to account for the labor spent doing work – especially when you own your own business. As one of your most substantial operational costs, it’s important to make sure you’re tracking every dollar. There are labor pricing software apps that can help you determine those costs.

Knowing how much it costs in labor to create your products or execute your services will help you determine the right price for those products and services. And it isn’t just the physical work that goes into the creation or execution. Consider the time and labor it took to schedule the service, take the order, or make the sale. All of that is labor that should be accounted for when pricing your products.

There are two general methods for determining your labor cost allocation: standard cost and actual cost. Each has their benefits and their limits, and identifying the right one for your business is vital to ensuring every dollar is accounted for.

Standard Cost

When looking at your labor cost allocation using this method, your company assigns the “standard” cost of labor for each product or service, instead of the actual costs of direct labor. In simpler terms, this means you determine how much it should cost in labor to produce your product or service, and then use that information to price it.

Let’s say you have a product that takes three employees two hours each to make, for a total of six labor hours, plus one employee 40 minutes to package and mail the item, and one employee 20 minutes to bill for the item. If each employee makes $25 per hour, and it takes 7 hours per item, then it costs $175 for each product.

This doesn’t take into consideration the materials or overhead required to make the product but gives you a simple idea of how to look at the standard cost of the product. If all things are equal, and it generally takes seven billable hours to build a product, then it costs your company $175 in labor for each product. This will help you decide the price of your product.

Actual Cost

Actual cost allocation takes into account all of the variables that come into play when building each and every product or executing each and every service.

Instead of using approximations or rounding up as you might do with standard cost allocation, you’ll need to use specific numbers to determine the actual cost of each product. To ensure your numbers are accurate, you need to make sure you have the right software or system in place to monitor every step of the production process.

The actual labor cost is much more complicated, but you need the information to ensure things are going in the right direction for your company. Knowing exactly where your labor dollars are being spent in the creation or execution of your products or services will help you keep your profits from flying out the window.

Using Both Standard and Actual Costs to Track Your Dollars

Standard cost creates a general idea of what the product or services costs to complete in terms of labor. But it doesn’t take into account the variables. That’s where the actual cost comes into play.

Maybe as time goes on, your employees become faster in their creation, and it ends up taking less time to build the product. Or you find the right shipping system to help streamline that process and knock it down from 40 minutes to 20, thus saving you additional labor costs.

When you have the standard costs down, you can compare it to your actual prices and determine the variances. Knowing the variances between your standard and your actual costs can show you improvements or decreases in your performances.

If your actual costs are lower than your standard costs, then things are moving in the right direction. If they’re the other way around, it’s time to identify the issues and course-correct.

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