Business Process Improvement – Calculating the Labor Cost

Have you ever wondered what a business process costs an organization or what the largest cost to a company building a product is anyway? It is usually either labor or materials, depending on the type of business, and over the decades we have seen a shift where overhead is consuming a bigger slice of the “product cost” pie.

While this article discusses business processes, and not product creation, labor is still a big cost component. So knowing how much labor a process consumes will help you better understand the cost. This article provides the basic steps on how to calculate the labor cost of a business process, which include:

List the process activities and times.

Identify the annual volume.

Determine the FTE number to use.

Determine the salary and employee benefit rate to use.

Here is more detail on each of these steps. I will use developing a product quote as the example.

First, you have to know the process time for the business process in question. Determine this by identifying how long each step in the process takes and total the actual time consumed by the activities. So, let us assume that it takes 46.0 minutes for each quote. Translated into hours, this equates to.8 hours (rounded up) to produce each quote.

Second, multiply the time from step 1 by the annual volume. Let us assume that we produce 3,200 product quotes a year. In our example, multiply the.8 hours (labor per quote) by 3,200 quotes (volume). This equals 2,560 hours spent on the quote process in a year (annual labor hours).

Third, decide what full-time equivalent (FTE) number you should use in your calculation. While the definition of FTE varies by business, it generally means the total number of hours an employee can be paid for in a work year. If an employee works 40 hours a week, then one FTE equates to 2,080 hours in a year (52 weeks x 40 hours per week). Of course employees may have holidays, vacation, and sick time available to them. To arrive at the right labor calculation to use, subtract the number of hours your company grants your employees for vacation, sick, and paid holidays.

In our example, I use 1,880 hours as the standard labor hours. I arrived at this number by subtracting 80 hours vacation, 40 hours sick time, and 10 days (or 80 hours) of paid holidays from the starting point of 2,080 hours in a year.

Once you know the FTE number to use, divide the answer in step 2 by the FTE number. In our example, divide 2,560 (total annual hours spent on the quote process) by 1,880 hours (FTE number) and you get 1.36 FTE. This means that the quote process consumes a little over one employee and almost 1-1/2 employees. Using the FTE concept enables you to account for percentages of an employee’s time spent on a business process.

Fourth, multiply the employee salary by the FTE number. For simplicity, assume the work of creating a product quote is completed by one type of employee – entry level clerks. If they earn $30,000 a year, multiply $30,000 by 1.36 (FTEs) to arrive at $40,800, the labor-only cost for the process.

Of course, most employees receive benefits, so you have to add your organization’s employee benefit rate (often referred to as “EB rate”) to the employee’s salary to arrive at the final labor cost for the business process.

If you have many different types of employees involved in a business process and they all earn different salaries, you will find it helpful to build a spreadsheet to perform the calculation.

Estimating process time and its associated cost is the fourth step to improving the effectiveness, efficiency, and adaptability of your business processes.

Copyright 2010 Susan Page