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What are Direct and ‎Indirect Labor Costs in ‎Construction? 

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When it comes to contracts, businesses and organizations must consider direct and indirect labor costs. As a constructor, this cost will determine where the construction business stands in terms of expenditure. 

Lately, the construction industry has been experiencing tremendous growth. According to some reports, the US construction industry witnessed a 2.1% employment growth from 2017 to 2022. With its fast-paced growth and trajectory, it’s crucial to understand the main difference between direct and indirect labor costs.

Many reputable companies provide helpful insight into jobsite analytics. These solutions make it easier to calculate costs and provide you with advantageous reports. Solutions such as https://smartbarrel.io can help construction firms accurately determine costs based on things like labor tracking. This information is vital since it gives a clear picture of business expenses and turnover. 

So how are these costs calculated, and how are they vital in determining overall expenses? In this article, we’ll explain everything you need to know about labor costs in construction. 

What are direct labor costs in ‎construction?‎ 

In the construction sector, direct labor costs involve expenditures related to regular working hours and overtime. Apart from that, it can also include payroll taxes and other expenses, including social security and medical funds. It’s mostly based around the laborers hired to build the structure, install materials, and maintain and operate the site.

In other words, direct labor costs involve all the costs that trace back to production. For example, the yearly salary of a welder working on a construction site. 

What is ‎indirect labor cost in ‎construction? ‎ 

In construction, indirect labor costs are the costs that are not directly involved in a construction project. These costs can include wages, benefits, and overhead costs related to hiring employees who are not doing the construction itself.

In a nutshell, it involves key persons like management officers, on-site contractors, supervisors, guards, and other governing bodies. 

For example, a project manager oversees the starting and due dates for the projects. They will guide workers to work at a particular pace to deliver the project before the deadline. 

Managers are also responsible for allocating relevant tasks. Since managers are mainly involved with giving directions on-site (rather than directly carrying out the construction of the project), the pay they receive is classified as an indirect labor cost.

The importance of calculating direct and indirect labor costs

Direct labor cost is an essential factor in determining a company's profitability. It’s the amount of money paid to employees for their working hours. This number is vital since it reflects the amount of money spent on employee compensation, and is critical in determining a company's overall profitability.

At the same time, indirect labor cost is an integral factor in calculating a company's total costs. It includes both wages and benefits paid to employees who are not directly involved in producing goods or services. Indirect labor costs can be a considerable expense for businesses. They can affect a company's profitability, so it’s better to calculate it cautiously.

Labor costs are fundamental when trying to determine the profitability of a business. By knowing the labor cost, a company can determine how much profit it’s making. Here are some other ways construction companies can benefit from calculating labor costs. 

Adopting fair labor management

‎US labor costs have experienced a 1.3% rise in the past few years. To accurately calculate profits, companies need to adopt fair labor practices by paying their employees reasonable wages and providing adequate benefits. 

By implementing fair labor practices, a company can gain an advantage over competitors. This is because fair labor practices are known to increase productivity and provide a better ROI. 

Optimizing production costs

‎According to research, around 30-50% of the total cost of construction involves labor costs. Another way a construction company can benefit from labor cost tracking is by improving its profit margin by optimizing production. 

When a company knows how much it will have to pay for labor, it can set a price for each product. Eventually, this will also help cut extra wages that could potentially harm ROIs.

To determine profitability

To determine profit margins, a company can look at the cost of labor compared to how much they’ve gained. A company will be able to decide on how much profit is being made on each project or phase. 

Most construction companies already have construction software at hand. This software can store and calculate all the costs involved in the business, allowing the company to easily compare expenses with competitors and determine whether they’re making enough profit.

How to calculate direct labor costs in construction

To calculate direct labor costs, you’ll need to know the total number of hours completed by workers on the project and their hourly wage rates.

For example, let's say the hourly rate is $20, and it takes around 1 hour to construct one unit. The direct labor cost per unit would equal $20 from the calculation of 20 x 1.

How to calculate indirect labor costs in construction

The indirect labor cost is calculated by adding the wages and salaries of the subcontractors and suppliers. 

To calculate indirect labor cost in construction, determine first the number of hours an employee works. 

Next, you’ll have to subtract the time off for each employee. Then, finally, multiply employee working hours by their hourly wage. 

Costs are important

Direct and indirect labor costs both have a great impact on the construction industry. To generate better ROIs and increase productivity, it’s important to leverage both costs parallel to each other.

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