How to Calculate Labor Burden and Overhead Rates

February 24, 2024

Your labor burden rate and your overhead are key components of any real time job costing system. With them, you can have a solid estimate of your labor costs and overhead as soon as time is entered on a job. Combine this with a knowledge of your material cost, and you can know your profit (or loss) and margin on a job as soon as you send the invoice, or on a larger job, get a projection of your profit or loss as the job progresses.

The first step to determining your burden rate and overhead is to pull all your expenses out of your accounting software that cannot be directly assigned to a job for a given period: maybe 6 months or a year. If you don’t supply materials (maybe you are a framing contractor, a finish carpenter or a software developer), this could very likely be all your expenses. You’ll also want to pull the total number of hours worked on jobs (ideally this will only be hours that can be associated with jobs, and not things like administrative work, etc). If you don’t have this data yet, you can make an educated guess to get you moving in the right direction and then update your numbers once you’ve got the data.

From here, you’ve got a couple options:

Option 1: Keep things Simple

Since the end goal is to be able to have a solid estimate of our profit in real time, combining our labor costs and overhead into a single number keeps things straightforward, and still gives us the real time feedback we need. To do this, simply take all your non-job-specific expenses and divide them by the total number of hours worked on jobs.

With this approach, Labor costs and overhead are grouped together and are calculated by multiplying the LaborAndOverheadRate by the total hours worked on the job.

Option 2: Break out Labor and Overhead

If you want to keep your labor and overhead costs separate, you’ll need to go through all your non-job-specific expenses and assign them to either labor or overhead. Some things will be obvious: payroll costs for field guys will be labor, office staff payroll is overhead, shop/office rent is overhead, etc. Other things are more of a gray area and are up to your discretion: fuel, vehicle maintenance and tools for example. For each expense type you’ll have to decide how you want to categorize it. Once you have your expenses split between labor and overhead you can calculate your labor and overhead rates. Your labor burden rate will be the total of the labor costs divided by the total hours worked on jobs.

To calculate your labor cost for a job, simply multiply your LaborBurdenRate by the number of hours worked on the job.

You then have a couple options for your overhead.

Option 2.a Estimate Overhead based on invoiced amount.

With this approach, you will calculate an overhead rate that is a percentage of the amount you invoice.

Then to calculate your overhead cost for a specific job, simply multiply your OverheadRate by the amount invoiced for that job.

Option 2.b Estimate Overhead based on hours worked

You’ll have to decide if estimating overhead based on hours worked or on amount invoiced makes more sense for your company. If you decide to go with the hours worked, then your formula will end up being very similar to your LaborBurdenRate formula.

Calculating your overhead cost will then be as simple as multiplying your OverheadRate by the hours worked on the job.

Option 2.c Remove overhead from your calculations entirely

Due to the fact that overhead is going to be made up of more or less of fixed costs, estimating overhead costs per job is going to be difficult if the amount of work you do varies a lot year to year. Because of this, it might make more sense to not even include overhead in your job costing calculations (as long as you remain aware that it is there!).

Option 3: Get More Sophisticated

If you do multiple different types of jobs, or if you’ve got a large range of pays for your team, you may want to get more sophisticated for a more accurate job costing calculation. This could involve breaking up your labor and/or overhead costs out by job type and calculating individual labor/burden rates per job type (or even job scope, stage, etc). It could also mean calculating a labor burden rate that would be a multiple of the employee salary and thus be individual to each employee.

No matter which method you chose, you’ll want to have an established interval where you rerun your calculations and update your numbers: maybe once a year or even once a quarter depending on how dialed in you want your job costing to be.

One thing worth noting: these are not necessarily “accountant approved” down to the last penny calculations to ensure every dollar is assigned to the correct bucket: that’s the job of your accounting software. The goal here is to have solid numbers you can use to get an accurate estimate of your profit and costs on a job in real time: allowing you to make decisions and adapt proactively instead of retroactively.

If you’d like to see a post that digs more into more sophisticated methods of determining job costs, or if you’d like to talk about what setting up a real time job costing system for your business might look like, don’t hesitate to get in touch!