What Is Burden Rate? (With Benefits and Formula)
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Running a company involves a lot of direct and indirect costs to ensure that it operates smoothly and successfully. The burden rate helps you calculate how much a company loses or profits after paying the necessary expenses. Understanding this rate and how to calculate it can help you determine essential factors for running a company, such as how much you can charge for products and services. In this article, we explain what this rate can help with, discuss the different types, explore their benefits, provide the formulas, and share some examples.
What is burden rate?
The burden rate is a formula that compares the direct and indirect costs of operating a company. You can use it to calculate the indirect costs of a company beyond typical inventory, payroll, and compensation expenses. It can provide you with a better understanding of the total costs of maintaining employees or inventory. These indirect costs include payroll taxes, manufacturing inventory, health insurance, travel expenses, vacation, sick time off, and pension contributions. Some people may refer to this rate as indirect production costs, manufacturing burden, factory overhead, or labour burden.
Using formulas can provide you with a more accurate idea of the total absorbed cost, which represents the full cost of providing or manufacturing a product or service, than the payroll alone. It typically considers all the indirect costs of hiring and retaining employees within a company that aren't readily apparent in the financials. It can help you better understand the total labour costs, profitability, and efficiency per employee.
Types of indirect production costs
There are two types of indirect production costs that businesses can calculate:
The labour burden measures how much a company incurs in total indirect costs to maintain its employees. It includes expenses that are beyond the employees' salaries and wages, such as payroll taxes, employee benefits, sick leave, training, and pension contributions. Some other factors to consider during this calculation include:
Paid time off
Dental and vision insurance
Student loan debt assistance
The inventory burden measures how much it costs to manufacture, store, and distribute the products sold to customers. You typically add manufacturing overhead costs to the cost of direct materials and labour to get the total burden cost of making the product. The inventory burden can also include any cost related to the amount of time equipment is running to produce all of a company's products. Some factors to consider during this calculation include:
Equipment and machinery
Stocking and storage
Building leasing and maintenance
The benefits of the indirect production cost formulas
Indirect production cost formulas are beneficial because they help a company better understand its total indirect costs. This helps it make informed and strategic decisions to ensure subsequent success and profitability. For example, understanding a company's total labour costs can help determine how to price products and services. It also helps a company understand how much it spends on machinery, inventory, and leasing. The benefits of using labour burden and inventory burden formulas include:
Documents employee costs
Employees are important to a company's success and can be costly to hire and retain. Maintaining employees within a company involves many direct and hidden costs. Knowledge of indirect production cost rates can help you make informed choices about hiring, keeping, and training employees. For example, it helps a company make decisions about the perks and benefits to offer employees, the number of people to hire, and the pay scale for each role.
Reduces unnecessary costs
Companies use burden cost formulas to determine how much they spend on employees and inventory. They use this information to identify unnecessary expenses and strategies to reduce those costs. For example, if the indirect production costs calculation reflects a high lease cost, managers might use this information to find cheaper locations that can manufacture or store the same quality of products. It also helps them make strategic choices about how much the company can spend on total labour costs to ensure profitability and operational efficiency.
Enables financial preparation
Indirect production cost calculations provide crucial information that helps a company make strategic decisions about budgets and future spending. For example, this rate can show whether the company is overspending and provides a means for comparison with previous budgets. This information helps a company determine how they can save or spend money more effectively when making hiring decisions or securing inventory resources. If the organization is overspending, management can make adjustments to save more money each year. It also helps a company stay prepared for unexpected expenses and allocate enough resources toward growth goals.
Helps make data-driven decisions
Companies typically make many important daily decisions regarding their goals and strategic direction. As these decisions impact their success and profitability directly, it's essential for them to make data-driven choices. Some challenging questions a company may address include laying off employees, expanding the business, changing locations, and hiring new employees. The calculation of indirect production costs provides companies with a better understanding of their overall financial standing. As a result, employers can make more appropriate strategic decisions that align with the company's goals better.
Burden rate formulas
The labour burden and inventory burden calculations are two separate formulas companies can use to gain a better overall understanding of production costs. Here are the formulas you can consider for calculating labour and inventory burden in different situations:
Calculating the labour burden
The labour burden formula considers the labour burden and payroll costs that a company has for all its employees. Payroll cost includes all salaries and wages of a company's employees. Labour burden cost refers to the additional expenses that a company incurs for employees, such as payroll taxes, pension payments, vacation time, and sick leave. Here's the formula to calculate a company's labour burden:
Labour burden cost / Payroll cost = Labour burden
Calculating the inventory burden
The inventory burden formula considers a company's manufacturing overhead costs and activity measures. Manufacturing overhead costs refer to the indirect costs necessary for an organization to produce a product or service. Examples of manufacturing overhead costs include production building rent, property taxes, insurance, depreciation of machinery, and utilities are types of manufacturing overhead costs. Activity measure refers to the time necessary for typical company operations. Here's the formula to calculate a company's inventory burden:
Manufacturing overhead cost / Activity measure = Inventory burden
Examples of labour and inventory burden
Here are some examples of labour and inventory burden calculations:
Labour burden calculation
Here's an example of a labour burden calculation:
An organization hires several new employees to collaborate on a project for a large client. The organization spends a total of $300,000 in salaries and wages each year to pay the employees. The company also pays for health care benefits, which cost a total of $35,000 each year, and has payroll taxes, which are $13,000 each year. In this case, the labour burden cost for the organization is $48,000, and the payroll cost is $300,000. Using the formula to calculate the labour burden of the organization:
$48,000 / $300,000 = $0.16
This means that for every new employee the organization hires for this project, it pays an additional $0.16 to cover the extra costs of having the employees.
Here's an example of an inventory burden calculation:
A manufacturing business pays $10,000 for utilities to operate the production plant. The company uses the plant 100 hours each month to make the products it sells. In this case, the manufacturing overhead cost is $10,000, and the activity measure is 100 hours. Using the formula to calculate the inventory burden of the organization:
$10,000 / 100 = $100
This means the manufacturing business incurs an additional $100 for every hour it uses the production plant to produce goods and services.
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