How much is an hour’s labour worth?
Keeping your head above water in business is often easier than you believe. What it requires is a deep understanding of the basic numbers that matter, such as labour costs. Over the last 25 years of working with the property services sector, I am constantly amazed by how little understanding many people who should know, in fact NEED to know, have about the things that matter most when developing a service offering.
Take for example the most basic of items that every business has: The cost of one hour’s labour, not just what it actually costs, but how much they must sell that labour for in order to make a return and possibly not put the family home at greater risk than it already is by being in business. That may seem melodramatic, but think about it for a moment.
Retailers must sell their product with a mark-up on what they pay for the item. If they do not know what it costs them, they will surely be out of business. Retailers have myriad other costs also, but let’s leave that for another time. Back to your business, every time you sell one hour of labour, there is a genuine cost in doing so. It starts with a base rate of labour. There is in most cases an industrial award that must be met by LAW. Unfortunately, over the last few years, we have seen people operating business with little regard for the industrial law, as they pursue the next win.
So notwithstanding that some people flagrantly and sometimes unknowingly disregard industrial law, you are no doubt not one of them and therefore must meet the conditions of the relevant award or enterprise agreement, or occasionally where no award exists, the minimum conditions of employment. Let’s split the cost of labour into pieces:
All employees are entitled to at least 4 weeks per annum annual leave, which is a part of your cost of labour. For ordinary employees (not on a salary) most awards provide for a 17.5% annual leave loading for the 4 weeks of leave taken. This loading is a legacy from the days when overtime featured heavily and compensated the employee for the fact that they would not receive overtime while they were on leave. Effectively for an employee who is entitled to 4 weeks leave per annum, that equates to 9.04% leave loading.
This used to be called sick leave, although with the advent of co-parenting and single parenting has been renamed to personal leave and depending on the award and classification of employee is somewhere between 5 and 10 days per annum. If you are fortunate enough to work in some companies, awards and government departments it could go as high as 15 days. At 10 days per annum, you should allow 3.04% to the base rate of wages. Keep this in mind when calculating your cost of labour.
Long Service Leave
Although the qualifying level has been reduced over the past 10 years from 15 years to 12 and pro rata payments being payable after only 7 years, there are fewer people that stay with an employer long enough to receive payment of long service leave. Notwithstanding the above, to fail to avoid providing for paying this at some point would be dangerous (especially where portability provisions occur).
As an employee becomes entitled to pro rata long service leave after 7 years (12 weeks for 15 years’ service but varying on certain awards), it is important that you provide for the taking of the long service leave. Allowing for long service leave accounts for approximately 1.5% of the direct wages paid. And that is just the start! A SUB total would be applied here for labour cost calculation.
The combination of the hourly rate, leave entitlements and long service leave are not the only costs that you need to provide for and the rest will be described here:
The Superannuation Guarantee Levy
The Australian Government legislated in the 1990’s that all Australians in the workforce would be entitled to a superannuation plan, effectively forcing all Australians to save for their retirement and therefore remove a dependence on social security and pensions in the future. For businesses, the superannuation is payable on all wages earned by an employee. For the purposes of that calculation, all wages includes direct wages, annual leave, personal leave and when the person finally gets to take it, long service leave. The current superannuation guarantee rate is 9.5% (1/8/17).
Another SUB total in labour cost calculation would be applied here: payroll tax. Don’t get me started, but the payroll tax is a state based tax paid by all employers who have reached a threshold. To say that payroll tax is a blight on business may reveal my hand, but to be taxed for the privilege of paying someone seems rather odd and if a business did this they would be accused of double dipping. The payroll tax varies between states and is something that all businesses should check with their accountants. Some states even rope in a new start business into payroll tax when there are common directorships in place.
WorkCover or Workers’ Compensation
An insurance charge that is payable by nearly every employer and is taken out to ensure the financial security of both employer and employee. It is payable by the employer on a combination of an “industry rate” plus loadings applicable to the employer that is based on claims history. The level that you pay is as individual as a company and when a company has a well managed employee program the rates and incidences of claims is often diminished.
Depending on the industry, its risk profile and a whole bunch of factors, the work cover rate could be in the very low single digits to very high teens. It is not to say that it could not be higher, but I have never seen them exceed 17.5%, although just as your travel insurer may decide to cancel your policy if you declared your desire to “run with the bulls in Pamplona”, I doubt that bull fighter’s would be very low, if even insurable.
It is important that you check your work cover rate and keep it up to date in developing your costings. It is charged on the total labour cost including Superannuation in most states, although can vary in the application of being charged. Another SUB total would be applied here.
Now we know the real cost of labour there are myriad other variables that would need to be added to come up with your hourly rate that needs to be charged. In cleaning it will be materials, equipment and depreciation, in consulting it will be travel, IT costs and other 3rd party lines, security will be cars, uniforms, communications. The costs that go into making your business operational, the tools of trade for want of a term. Again a SUB total will be applied here.
At this point in time you should just about have your hourly operational cost which will only leave you with what you need to add to generate a commercial return and allow for your administrative overhead. For all businesses this will vary, even though there will be industry palatable standards and or expectations. Whilst that is the case, to think that a business did not need to add at least 13-15% total contribution would suggest that some level of financial distress could occur.
In the cleaning industry, where I have spent the best part of 25 years, companies will attempt to win work with a contribution margin of 6 or 7% which to my way of thinking will almost certainly mean one thing in the long term. Trouble with a capital T.
The Final Word
You must be realistic in your expectations, in balancing a need to win business and then being able to deliver it. Sustainability is not just eco or green, it is sustainable in that it doesn’t endanger the very survival of the business. It is not against the law to make a profit, nor should it be against the law to pay a service provider a price that allows them to generate a profit, but it is against the law to pay people in undeclared cash, or below the conditions and standards of the Industrial instrument applicable to their classification of work. Calculate your cost of labour correctly, price well, operate legally and make a profit. Oh, and don’t forget to add the GST!
Special Note Purchasers of Services
Knowing what DLTS is, as an indicator is critical. It is Direct Labour To Sale and is identified in percentage terms. It is the most important ready reckoner for a purchaser of services to be able to apply. It pre-warns the buyer that financial distress is likely and must be known by a client. In a labour intensive industry such as cleaning or security, that number is around 63%. If a contractor says that can sell you an hour’s labour at more than 63% beware. They need to operate profitably and realistically need to operate at less than 60% DLTS and will do everything they can to get to that figure or below it.
Save yourself the grief that comes from working with a contractor who will enter financial distress by working with you for an unsustainable rate. If you like them, respect them and want to work with them, then do yourself and them a favour by insisting on paying more or negotiating to receive less.