Definition of Labor Cost
Wages and labor are usually the most expensive part of running a business. Companies develop strategies to limit the amount of wasted labor hours in their labor force and limit the amount of capital spent on labor. The allocation of labor is a classic economic theory that attempts to determine how much manpower is needed to effectively produce a certain amount of goods or services. Companies use this economic theory along with traditional management accounting process to determine the amount of labor needed for their production processes.
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Types
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Labor costs are typically broken down in one of two groups: variable or fixed. Variable labor usually includes hourly employees or individuals who are paid on a contract basis. Companies use variable labor to avoid paying higher wages or benefits to employees, which exponentially increase the company’s operational costs. Fixed labor represents salaried employees who are paid certain wage amounts regardless of the amount of hours they work. Companies benefit from fixed labor by not having to pay for any overtime worked by employees.
Features
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Inside the two basic types of labor cost, variable or fixed, are two labor subgroups: skilled and unskilled. Skilled labor is usually the more expensive labor subgroup since individuals in this category have specific technical or analytical business skills. Companies usually have to pay a premium when hiring workers with these skills. Unskilled labor usually represents individuals with no technical business skills; companies hire these individuals to complete manual tasks or processes in the business operations.
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Considerations
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Companies develop hiring practices to track labor costs and determine when new employees might need to be hired or current employees laid off. These decisions can be based on employee production efficiency calculations. When employees are unable to meet production output requirements in a timely manner, more employees might need to be hired. If employees are taking more time than is necessary to produce goods or services, the company might need to lay off employees to decrease labor costs and improve production efficiency.
Theories/Speculation
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Labor cost is important to businesses because it is the way they track the productivity of their employees. Spending too much money on workers who fail to produce a certain amount of goods can lead to negative cash flow situations and cause the company to become unprofitable. Productivity numbers are also used as the company grows, expands or purchases new operations so the company can determine how many employees will be needed for expanded operations.
Expert Insight
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The U.S. Department of Labor publishes information related to specific labor and productivity information for various business industries or sectors. This information can be used by companies to determine how well they match up with industry standards. Companies should attempt to maintain industry labor and productivity standards to avoid losing their competitive advantage in the business environment.
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