How to Calculate Labor Cost: Formula, Example, and the True Cost of an Employee

Labor cost equates to the total amount a business spends to employ someone: wages, employer payroll taxes, benefits, and the cost of hiring and training. To calculate it, add those costs for each employee, then divide by the hours that person works. In June 2026, benefits made up 30% of what private employers spent on compensation, according to the Bureau of Labor Statistics. For a customer service representative paid $42,085 a year ($20.23 an hour), that puts annual labor cost at about $54,300, or $28.90 per hour. In the first year, hiring costs push it to about $31.80 an hour.

Below, we break down every piece of that number, walk through the formula step by step, and give you a calculator for your own figures. We also show how the math changes when you bring someone on through a staffing agency instead of hiring them directly.

What Is Labor Cost?

Labor cost is the total amount a business spends on the people who do its work. Payroll is the biggest piece, but every dollar of wages comes with employer taxes, benefits, and paid time off, plus the one-time cost of recruiting and training each new hire.

Direct labor cost covers the people who make your product or deliver your service, such as production workers or call center agents. Indirect labor cost covers the people who support them, such as supervisors and HR staff. Both belong in your total, although manufacturers and contractors often track direct labor separately to price jobs accurately.

What’s Included in Labor Cost?

The Bureau of Labor Statistics tracks what private employers spend on compensation for every hour their employees work. Its June 2026 figures show where the money goes:

Benefits add about 43 cents to every dollar private employers pay in wages.

Private industry employer costs per hour worked, June 2026

Source: U.S. Bureau of Labor Statistics, Employer Costs for Employee Compensation, June 2026 (released September 9, 2026). Shares may not add to 100% because of rounding.

Every new hire also brings one-time costs that BLS doesn’t count, including recruiting, background checks, onboarding, and the weeks before a new employee is fully productive. SHRM’s 2025 benchmarking puts the average cost per hire for a nonexecutive role at $5,475.

How Do You Calculate Labor Cost?

Calculate labor cost one employee at a time, then add your employees together for a team or company total. The formula is:

Annual labor cost = base pay + employer payroll taxes + benefits and other pay + hiring and training costs

Step 1: Start with base pay

For an hourly employee, multiply the hourly rate by the hours you pay for in a year. A $20-an-hour employee on a 40-hour week is paid $41,600 a year ($20 × 40 × 52). For a salaried employee, use the annual salary.

Step 2: Add employer payroll taxes

Employers pay 6.2% of each employee’s wages for Social Security, up to the 2026 wage base of $184,500 (rising to $192,300 in 2027), plus 1.45% for Medicare with no cap. Federal unemployment tax is 6.0% of the first $7,000 of wages, but employers who pay state unemployment tax on time generally get a credit of up to 5.4%, so the federal cost is usually $42 per employee.

State unemployment tax rates and wage bases vary by state and by your claims history. Workers’ compensation insurance varies by job: on our own policy, office and clerical roles fall inside our standard burden, while electrical and field service work adds about 4% of pay. Across private industry, state unemployment and workers’ compensation together average about 1.6% of pay.

Step 3: Add benefits and other pay

Add what you spend on health insurance, retirement contributions, and other benefits, plus overtime premiums and bonuses. If you don’t have exact numbers yet, BLS averages are a reasonable starting point: insurance, retirement, and supplemental pay together work out to about 19.6% of pay for private employers.

Step 4: Add hiring and training costs

Add what it costs to recruit, screen, and onboard the person, including job postings, recruiter time, background checks, and the training hours before they’re fully productive. SHRM’s $5,475 average is a useful placeholder if you don’t track your own cost per hire. Count it in the first year only.

Step 5: Convert to cost per hour worked

Divide the annual total by the hours the employee works, not the hours you pay for. The difference is paid leave: vacation, holidays, and sick days, which average about 9.7% of pay for private employers. A full-time employee paid for 2,080 hours a year works about 1,878.

Labor Cost Example: A $20-an-Hour Employee

Here’s the full calculation for a customer service representative paid the national average of $42,085 a year ($20.23 an hour), according to our salary data. Where costs vary by employer, we used the BLS averages above.

A $42,085 customer service representative costs about $54,300 a year, or $28.90 for every hour worked.

Estimated annual labor cost for one full-time employee

Estimates. Your state unemployment rate, workers’ compensation class, and benefits plan will change these numbers; use the calculator below to estimate your own.

Labor Cost Calculator

Enter a wage or salary to estimate the fully loaded cost of one employee. The defaults are the private-industry averages used above, so change any of them to match your business.

How Does Labor Cost Compare With Using a Staffing Agency?

When you bring someone on through a staffing agency, the agency is the employer of record. You pay one hourly bill rate, and the agency covers the worker’s pay, payroll taxes, and workers’ compensation, along with recruiting and payroll administration. Staffing agencies typically bill 1.5 to 1.8 times the worker’s pay. At 4 Corner Resources, contract bill rates range from 1.45 to 1.75 times pay, quoted as one all-in hourly rate before the search starts.

In the first year, a $20.23-an-hour employee costs $31.81 per hour worked, inside our contract bill rate range.

Customer service representative at $20.23 an hour: your employee compared with a contract worker through 4 Corner Resources

Employee figures come from the example above. The typical market range of 1.5 to 1.8 times pay works out to $30.35 to $36.41 an hour. See our pricing page for every service.

For a role you’ll need for years, a direct employee usually costs less per hour once the hiring cost is behind you. For seasonal peaks, short projects, or a role you aren’t sure you’ll keep, a contract worker can cost about the same per hour worked, without the hiring cost or the long-term commitment. Contract-to-hire sits in between: you see the person do the work before you add them to your payroll.

Our post on how much staffing agencies charge breaks down what goes into a bill rate, and our contract staffing page explains how the service works.

How Do You Calculate Labor Cost Percentage?

Labor cost percentage shows how much of your revenue goes to labor:

Labor cost percentage = total labor cost ÷ total revenue × 100

A business with $2 million in revenue and $600,000 in total labor cost has a labor cost percentage of 30%. A healthy number depends on your industry, since service businesses spend a far bigger share of revenue on labor than most manufacturers or retailers do. Compare your business with similar ones, and track your own percentage over time.

How Can You Lower Labor Costs Without Cutting Pay?

• Manage overtime. Federal law requires 1.5 times the regular rate for nonexempt employees after 40 hours a week, so track overtime weekly and add help ahead of predictable peaks.
• Reduce turnover. Every replacement brings another hiring cost and a stretch of lower productivity. Our guide to employee retention strategies covers what keeps people from leaving.
• Use contract staff for peaks and projects. Paying a bill rate only for the hours you need can cost less than keeping a full-time role on payroll through slow months.
• Review benefits costs every year. Plan design and carrier choice change the 7.9% insurance share more than most employers expect; here are 9 ways to lower employee benefits costs.
• Fill open roles faster. An empty seat still costs money in overtime and lost output, as our post on the cost of vacancy explains.

Need Help Planning Your Labor Costs?

If you’re weighing a new hire against contract help, we can quote an all-in hourly rate for the role before you decide. Tell us about the role, and we’ll walk you through the numbers.

Frequently Asked Questions

Sources
U.S. Bureau of Labor Statistics, Employer Costs for Employee Compensation, June 2026
IRS, Topic 751, Social Security and Medicare withholding rates
IRS, Topic 759, Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Social Security Administration, Contribution and Benefit Base
SHRM, SHRM Releases 2025 Benchmarking Reports
U.S. Department of Labor, Overtime Pay
4 Corner Resources, Customer Service Representative Salary Data

About Stacey Haley

Stacey Haley is the CFO of 4 Corner Resources, a nationally renowned staffing agency. She has eight years of experience in public accounting as well as seventeen years of consulting in the private sector. As a CPA, Stacey works closely with decision-makers and shareholders for small and medium-sized businesses. Her vast experience varies from debt financing, auditing, cash flow management to mergers and acquisitions. In her free time, she enjoys horseback riding and being outdoors!