Direct labor costs are the portion of a company payroll that goes toward the wages of employees who are directly involved with making a product or rendering a service. They are distinct from indirect labor costs, which refer to the wages of those associated with the creation of the product but not in the direct line of production, such as machine-repair technicians. Understanding direct labor costs is an important part of creating a budget and business cost analysis.
The best way to determine if a particular employee's wage contributes to direct labor costs is to ask if a specific product could be made or service given without their work. A person that installs the doors on a car is a part of the direct labor line, because without him or her, the car would be unfinished. In a housekeeping business, a maid who goes out on jobs would be considered direct labor, as without her, the house would not be cleaned. Those involved in indirect labor costs might facilitate the process, such as administrators that book jobs or sales personnel that market a product, but the product or service could still exist without them.
Dividing workers by their contribution to direct or indirect labor costs helps determine the total cost of a service or product. For instance, while all businesses may need administrators, janitors, and other indirect workers, the number of workers and wages required may be different if a company makes teddy bears or baby dolls. For a toy company to decide which product it should make, it will need to look at the material costs plus the direct labor costs as compared with the anticipated profits. If teddy bears can be made for considerably lower direct costs, it may provide a higher profit margin for the company and thus be a better choice.
In order to figure out direct labor costs, a business must analyze several factors, including the cost in wages per unit of production, and the desired quota of each product. If a business wants to make 100 teddy bears per week and each employee can make one teddy bear per hour, it will take 100 hours to meet that quota. By multiplying the amount of hours needed by the per-hour wage of the employees that make the bears, the business will know how much the direct labor costs of making 100 teddy bears per week. Therefore, if there are two employees that each work 50 hours per week and are paid $10 US Dollars (USD) per hour, the direct labor costs of making 100 teddy bears could be expressed as: 2 employees X 50 hours X $10 USD= $1000 USD.