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How to Calculate Labor Cost: A Formula for Restaurants

How to Calculate Labor Cost: A Formula for Restaurants

How to Calculate Labor Cost: A Guide for Restaurant Owners

Business owners have to deal with a number of major operational costs: rent or mortgage payments, inventory costs, labor costs, and a few others depending on the industry. This post will focus on the last item in the list, and explore all the steps involved in how to calculate labor cost. 

In the restaurant industry, average labor is about 30-35 percent of business revenue, making it one of the most costly expenses. 

From the staff to cook and serve the food, to those who handle cleaning and management, the cost of labor for all of these functions adds up quickly. Many variables factor into labor costs. Being on top of these expenses is important for the survival of the business.

However, many owners struggle with the challenge of keeping their labor cost low. What is involved in this process exactly? 

What is Labor Cost and Why Do Business Owners Need To Calculate it?

Labor cost is the total dollar amount your restaurant spends on employees, including pay for salaried and hourly workers, as well as taxes and employee benefits. The amount you spend on labor also impacts your prime cost – total cost of goods sold plus total labor cost – which is the metric that many restaurateurs use to examine their restaurant’s efficiency.

It’s important to remember that labor costs are far more than hourly or salaried wages (though those are a big chunk of the total). But in actual fact, labor costs include such expenses as payroll taxes, overtime, health care, bonuses, sick days, vacation days, insurance, benefits, meals, supplies, training costs and more.

Basically, consider anything even remotely related to employee wages as a labor cost.

What that means for you, then, is that while you may pay your servers $15 per hour, your actual labor costs are much higher because you have to factor in all the other expenses.

Here’s how to calculate your full labor cost. Basically, anything that can be categorized as labor-related goes into your labor cost percentage calculation.

Why do you need to calculate it? 

Acceptable labor cost percentages can run anywhere from 25 to 40 percent of a restaurant’s gross revenue. High-end restaurants that devote considerable attention to creating a fine dining experience and making all menu items from scratch will land on the high end of this spectrum. Fast casual restaurants with simple menus and items purchased from food service warehouses and reheated, usually land on the lower end.

To understand your payroll numbers and assess where there is room for improvement, track hours relative to labor functions such as front-of-house and back-of-house operations. This information can tell you whether parts of your restaurant are inefficient or overstaffed, and show you where payroll costs can be trimmed.

What is Restaurant Labor Cost?

Labor cost is the total amount spent on the staff on your restaurant’s payroll. Some business owners make the mistake of only including the wages of hourly workers into their labor costs. Restaurant 365 defines these direct wages as “unburdened labor.” On the other hand, “fully burdened labor” refers to additional expenses paid out, like salaried employee wages, employee benefits like healthcare, and additional costs like payroll taxes and Social Security.

To calculate labor costs, you need both. Add up all expenses related to wages, benefits, and other fully burdened labor line items. A labor calculator can help you with this process.

However, the total cost alone doesn’t paint the full picture. For labor costs to mean anything, they need to be compared to your overall sales.

How to Calculate Labor Cost Percentage

Labor cost percentage is the relationship between your labor cost and your total revenue over the same timespan. To calculate your labor cost percentage, divide your labor cost by your total sales for the same period. You can plug your total sales into a labor cost calculator to get your labor cost formula.

To calculate, we’ll set up a hypothetical employee who works full time, is paid hourly and that has a pay rate equal to $15 per hour. 

Determine Gross Pay

When an employee works full time, they will potentially work 2,080 hours in one year (40 hours x 52 weeks). So you’ll start with this equation:

  • Gross Pay = Pay Rate x Gross Hours
  • Gross Pay = $15/hour x 2,080 hours
  • Gross Pay = $31,200

Calculate Hours Not Worked And Net Hours Worked

You’ll never know exactly how many times an employee will be absent, but you can hazard a pretty good guess. If you have past records for other employees, average their absentee numbers together and apply that number to a new employee.

Let’s say you come up with an average of 10 days lost because of holidays, vacation, and illness.

Convert that estimate to hours with the following equation:

  • Hours Not Worked = 10 days x 8 hours
  • Hours Not Worked = 80
  • Now subtract those hours not worked from the total hours worked from the first step (2,080).
  • Net Hours Worked = Gross Hours – Hours Not Worked
  • Net Hours Worked = 2,080 – 80

Net Hours Worked = 2,000

Add Other Annual Costs

Remember, labor costs include expenses other than just wages. Insurance, bonuses, taxes — all of these items have an impact on what you pay your employees.

Calculate Actual Hourly Labor Cost

You know your employee’s base pay rate ($15 per hour in this example), but it’s essential that you calculate their actual hourly labor cost using this restaurant labor cost formula:

  • Actual Hourly Labor Cost = Annual Payroll Labor Cost / Net Hours Worked
  • Actual Hourly Labor Cost = $35,200 / 2,000
  • Actual Hourly Labor Cost = $17.60 per hour

That number tells you that when all the other variables are factored in, you’re paying your employee $17.60 per hour of actual work.

How To Control Labor Cost

Lowering your labor costs doesn’t mean you have to pay your employees less. In fact, there are better ways to decrease one of the biggest expenses for your business. Here are a few tips to help you get control of your labor costs.

1. Plan Your Schedule In Advance

Planning your schedule well in advance is one of the best ways to lower your labor costs over the long term.

We recommend creating your employees’ work schedule at least a month in advance. This gives you plenty of time to review, tweak, and perfect the hours worked in order to minimize labor costs while still covering all shifts.

It also gives your employees time to find substitutes for days they can’t work so you’re not left short-staffed.

2. Tabulate Labor Costs As You Schedule

Calculating labor costs can be a laborious task. There are so many moving parts — who can work when, part-time vs. full-time, pay rates, overtime — it’s easy to get lost in all the numbers and become overwhelmed.

Plus, there’s the fact that once you have a schedule that works, something inevitably comes up that requires changing one or more pieces. And once you alter one variable, all the other variables and calculations usually change as well.

3. Incorporate A Rotating Shift

A rotating shift is a scheduling system in which employees move through a cycle of working the day shift, the night shift, and any swing shifts that may be necessary.

For some businesses, the rotating schedule may be first shift, second shift, third shift. For restaurants, the rotating schedule may be opening shift, lunch shift, and dinner/closing shift.

4. Train Employees To Fill In At Other Positions

Training your employees to be proficient at their jobs is essential for the success of your business. Consider cross-training them to be proficient at another job as well to help reduce your stress and keep labor costs low.

5. Monitor Overtime Hours

Monitoring overtime hours is another essential way to keep labor costs low. If left unchecked, overtime hours can quickly become a huge drain on your budget and affect your bottom line for the worse. It’s imperative to keep your employees’ overtime hours as low as possible so they don’t get out of control. The best way to do this is with software.

The Relationship Between Labor Cost and Prime Cost

Many restaurant owners find it more useful to assess their margins by looking at prime costs, or ingredients and labor combined, rather than looking at labor costs in isolation. It may be sustainable to have higher labor costs if your food costs are lower or vice versa.

Food and labor costs together should equal about 66 percent, or two thirds of your gross revenue. You may have higher labor costs because you make all of the elements on your menu in house, balancing the labor expense by saving money on ingredients. Alternatively, you may buy prepared items from another business or from a food service warehouse. This strategy may reduce your labor costs but may increase your food costs.

Although labor is typically regarded as a variable cost, one that fluctuates relative to the amount of business you transact, your restaurant incurs fixed labor costs to maintain a skeleton staff, even if no customers walk in your door. 

The dynamics of managing finances in a restaurant can be intimidating. Hopefully, this guide on how to calculate labor cost gives you a clearer path towards managing the financial future of your restaurant.

Revel Systems understands the unique needs of the restaurant business. Our iPad POS system is designed from the ground up with business owners in mind. It can simplify day to day tasks to save time and trim costs. Contact us today to receive a free demo of the industry leading restaurant POS system