Indirect labor costs are those related to running a company and selling a product or service versus the actual labor-related costs to make that product or service. Knowing the difference can help you create better financial reports and strategic plans based on your ability to calculate your overhead and production contributions to your costs of goods sold.

Labor Costs

Labor costs are those related to hiring people to work for you; they include salaries, hourly wages, bonuses, commissions, benefits, insurance and taxes. Depending on how detailed you want your labor costs, you can include worker training, health care costs, awards and wellness programs. Some companies include the cost of uniforms, certification fees, licenses, tools and equipment necessary to perform a task as part of their labor costs. This helps an employer more accurately determine the cost of using in-house labor vs. a contractor. Most companies put expenses like these under dues and subscriptions or equipment and supplies categories since they are only related to labor.

Indirect Labor

Indirect labor costs are those labor expenses not directly related to making your product or creating your service. For example, if you manufacture widgets, your receptionist, human resources director, marketing manager and accountant are indirect labor costs. If a restaurant owner manages the business and acts as the head chef, he would divide his salary between direct and indirect labor based on the number of hours he worked in each capacity and the value he applied to each. To calculate the value of each of his roles, he would determine what he would need to pay someone to do those jobs.

Direct Labor

People who work to make a product or service, rather than sell it or market it or run the company, are direct labor. At a widget factory, the line workers and their shop managers are examples of direct labor. At a restaurant, the cooks, dishwashers and servers are direct laborers. The stylists at a salon fall into the direct labor category. If one of them also handles marketing, keeps the books or works part-time as a receptionist, her wages would be split between indirect and direct labor costs to help calculate overhead costs to better set the shop’s rates.

Overhead vs. Production Labor Costs

To effectively set prices and to determine what happens to your profit margins when you increase or decrease your sales, it’s important to calculate your expenses for making one unit of your product or service. Expenses such as your direct labor, materials, supplies, machinery maintenance and energy costs go into your manufacturing, or production, expense category. Your office staff, marketing, rent, phones and other expenses that continue even when you stop making product go into your overhead expenses. As you make more units, your overhead costs per unit go down. As you increase your sales, your gross production costs rise and your cost-per-unit will likely decrease, but at a different rate than your overhead cost per unit. This is because your labor costs might or might not change, depending on whether you make enough extra units to cause your staff to work more hours. You might also get a bigger discount on larger materials orders, reducing your production costs.