How To Calculate Labor Cost in Construction

Accurate labor cost calculation is critical in construction and can help construction companies better manage budgets, improve bidding accuracy, and enhance overall financial performance.  

Fortunately, once you learn how to simplify the calculation formulas, master detailed record-keeping, and find software that makes all of these tasks easier and more accurate, you position yourself for financial wellness, long-term profitability, and adaptability.  

What Makes Labor Cost Calculation Uniquely Challenging in The Construction Industry 

Labor tracking is the process of accurately recording and entering any labor costs associated with a particular construction project representing what an employee or subcontractor did during their shift. Payroll specialists take the time sheets they fill out, categorize the hours based on job codes, and process payroll accordingly. 

Labor costs are broken down into three categories: 

• Direct labor costs (wages, salaries, and benefits)  

• Indirect labor costs (payroll taxes, insurance, and worker’s compensation) 

• Overhead costs (administrative expenses, equipment, and facilities)  

In the construction industry, this is especially important to track accurately. It can also be highly-complex because back-office accounting must juggle multiple job sites, job codes, equipment, and observing compliance.  

When executed correctly, labor cost tracking can improve project cost projections and help drastically reduce the risk of error.  

How Your Labor Cost Data Impact Your Profitability  

From job costing to maintaining positive relationships with your employees, inaccurate labor cost calculations influence success in many areas of business.  

Did You Know? According to recent stats from G2, 49% of US workers would consider changing jobs after two errors with their payroll. 

However, if you use software and strategies that ensure high-quality calculations, you can boost growth on a consistent basis. Here’s how data quality makes an impact: 

• Maintains project budgets and prevents cost overruns. When you implement labor cost management strategies, you can monitor, in real time, how and where costs add up–thus helping avoid cost overruns before they happen. 

• Understand legal ramifications of inefficient labor cost calculations. The construction industry is infamous for its strict and ever-evolving compliance regulations. Staying ahead is crucial to avoid costly penalties, and the following statistics illustrate just how difficult they are to avoid with manual data entry processes. 

• 30% of small business owners participating in a SurePayroll survey say they’ve made at least one payroll mistake, (including underpaying an employee)--and 42% of those surveyed said they relied on DIY payroll solutions. 

• In 2023, the IRS uncovered more than $4 MILLION worth of cases in civil employment tax penalties, resulting in penalty payments (nationally) exceeding $1.5 billion. 

• Ensures competitive and profitable bids: When you have a clear picture of what labor costs look like per project, you can achieve a competitive edge when bidding for projects. Those fine details eliminate guesswork, and help you identify the most competitive price that yields the best possible profit. 

How to Calculate Labor Costs Step By Step 

With a richer understanding of the significance of labor cost calculation in the construction industry, we’ll delve into how to actually calculate the different components.  

Step 1: Identify labor rates: Determine hourly wages and salaries for different roles and create a master sheet that includes pay rates based on experience and job function. 

Step 2: Calculate direct labor costs: Direct labor costs cover wages, salary, and benefits. For each employee, take the total hours worked and multiply that number based on their hourly wage rates. Include any overtime or premium pay rates in your formula. Here’s an example of what the formula can look like 

[Total hours worked (including overtime/premium pay)] x [Employee’s hourly rate]   

Step 3: Factor in indirect labor costs: Be sure to calculate indirect costs like: 

• Payroll taxes 

• Insurance premiums 

• Retirement 

• PTO 

• Mandatory contributions per employee 

Step 4: Account for overhead costs: Even though they aren’t directly related to a worker’s hours, you need to include overhead expenses, such as general administrative expenses and project-specific overheads, into your labor cost calculations as well. 

When you calculate labor costs to include overhead, divide the total overhead expense by the number of direct labor hours within a specified time period. This will give you an “overhead allocation rate”. Multiply your “overhead allocation rate” by the direct labor hours needed to complete a job.  

Example: 

[Total overhead expenses associated with project] ÷ [direct labor hours within X time period] = [Overhead allocation rate] 

 Then… 

 [Overhead allocation rate] x [Labor hours needed to complete project] = [Your final overhead cost] 

- Using a percentage of direct labor costs to distribute overhead.  

Calculating overhead costs gives insight into your “true project cost”, so you can see the true profitability of the project, and helps you avoid underestimation of expenses.  

How Software Can Help Calculate Your Labor Costs  

Integrating dedicated resource management software (like Sage, Procore, or hh2) can greatly optimize labor tracking and calculations via automation.  

Did You Know? Companies who automate payroll experience 33% higher operational efficacy by streamlining tasks and reducing errors. 

To get the most out of your software as a construction company, choose a solution with the following features.  

• Industry-specific. Construction is a uniquely complex operation due to intense regulations and complicated job coding. Therefore, it’s critical to choose software that intimately understands and adapts to the industry. 

• Comprehensive suite of tools. From job coding and time tracking to document scanning and workflow automation, the accounting system you choose should harmonize your workflow by covering all the bases.  

• Integration with payroll and accounting systems. Even if you aren’t handling your payroll with spreadsheets, the right labor calculator software should seamlessly transfer (and interconnect) data throughout your stack. For example, hh2 back-office cloud platform unifies your software system, eliminating information silos and bottlenecks in your payroll process.  

For a real world example, learn how hh2 helped Miller Construction decrease payroll errors to nearly 0%. 

• Mobile-device capabilities. Your W2 workers and subcontractors may move to multiple job sites per day, which is why you need a payroll system that supports on-site and remote communications. 

• Real-time data synchronization and automated calculations. Choose a software solution that accurately synchronizes data in real-time and automatically calculates costs to ensure the most accurate and efficient reporting process. 

• Reducing manual entry errors and enhancing efficiency. The most instantaneous and cost-effective benefit of using dedicated construction payroll software is the accuracy. Aside from the money saved from correcting human error, your payroll specialist also saves time because software like hh2 automates these processes–creating more bandwidth for higher-priority tasks. 

• Consistent and user-friendly interfaces across all devices. The solution should be user-friendly and intuitive for everyone on your team. Whether on a cellphone, tablet, or a desktop computer, it should be equally easy to use regardless of the device the user is on.  
  

Best Practices for Accurate Labor Cost Calculation 

There are steps you can take, whether you’re operating manually or digitally, to ensure optimal labor cost calculations. Industry-dedicated solutions like hh2 can automate these processes for you–or make them much easier to manage, but these tips are applicable regardless of where you’re starting from. 

• Regularly update labor rates: Creating routines that ensure wage rates and benefits information stays current will save hours of corrections and headaches later.  

• Stay on top of worker regulations: Give your accounting professionals the support and resources they need to stay ahead of regulations–that way they’re always ready to adjust to changes in labor laws, and union agreements.  

• Implement comprehensive time tracking and approval processes: Being that many construction firm managers and owners are in the field, and workers may travel to multiple sites in a week, accurately recording labor hours, and implementing multi-level approval systems for validation, can reduce errors–as well as frustrating back and forth between payroll and management.  

• Detailed record-keeping protocols: The success of your labor cost calculations hinges on accuracy. Thus, maintaining detailed records ultimately yields better ROI, and generates a wealth of high-quality historical data to inform future bids, and estimates.  

Your team deserves a fluid and intuitive back-office experience. By optimizing labor cost calculations–and your payroll and project management processes as a whole–you're better equipped to adapt to changing markets and position yourself for long-term growth. 

Book your demo today to see how hh2 solutions streamline labor cost calculations and improve project profitability.