Direct Labor Budget- Definition, Example & More

Producing goods requires extensive planning and budgeting to ensure the company has all of the necessary resources to sustain profits. Poor budgeting can result in excess inventory that leads to waste or item shortages causing the businesses to lose potential sales.

By calculating a direct labor budget, manufacturers can determine if they have enough employees to complete a project and ensure the production budget coincides.

What is a Direct Labor Budget?

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A direct labor budget calculates the total number of labor hours required to manufacture the units in the production budget. Complex labor budgets take it a step further by also breaking down the labor into categories. The primary purpose of these budgets is to determine how much money goes to employees for completing a manufacturing project.

Direct labor budgeting is also an excellent tool for determining how many employees are needed in production during the budget period. This enables management to create staff schedules, hire new employees, request overtime, and coordinate layoffs if necessary.

Businesses usually hold monthly or quarterly meetings to create or update the budget. The standard direct labor calculation multiplies the number of manufacturing units from the production budget by the number of hours needed to produce each unit. This formulates the subtotal of direct labor hours required to meet the set production benchmark.

Management can choose to add more hours to the budget to account for supply chain disruptions and production inefficiencies, increasing the number of direct labor hours. If managers decide to add hours, they need to calculate the new total number of direct labor to arrive at the final cost.

5 Steps to a Direct Labor Budget

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Due to the continuous rise and fall of demand, companies should frequently refigure their direct labor budgets to anticipate new hires and layoffs. Direct labor budgets are also required whenever a new manufacturing project is presented, as labor costs are dependent on the company's production expectations.

Once management determines how many production units they need to manufacture, they can begin calculating the direct labor costs-

1. Calculate Labor Rate per Hour

First, organizations need to average all of the manufacturing department's wages by totaling the wages and dividing it by the number of employees.

Total Labor Wages Paid in an Hour / Total Employees = Hourly Labor Wage

2. Determine Direct Labor Hours per Unit
Then it is time to calculate the number of direct labor hours needed to produce each unit. In this step, it is essential to include all departments that handle goods during production.

For example, clothing manufacturers would need to consider manual labor to cut, sew, and finish an article of clothing.

3. Calculate the Labor Cost per Unit
Now that the hourly wage and number of labor hours per unit have been established, they are multiplied to determine the direct labor cost per unit.

Labor Hours per Unit x Hourly Labor Wage = Labor Cost per Unit

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4. Calculate Total Direct Labor Cost

The total labor cost can finally be calculated by multiplying the cost per unit by the total number of units the company needs to produce.

Labor Cost per Unit x Total Number of Units = Total Labor Cost

5. Break Down Labor Costs

Management should also take the time to break down the total labor costs into monthly intervals to determine how many units the company will produce each month. Multiplying the monthly quota by the labor cost per unit shows the minimum direct labor budget to keep each month.

Monthly Quota x Labor Cost per Unit = Monthly Direct Labor Budget

For example, a manufacturer pays a total of $2400 in labor wages per hour among 160 employees, making hourly labor wages $15-

$2400 / 160 = $15

Management reports that it takes approximately half an hour to produce one unit, making the cost per unit $7.50-

$15 x .5 = $7.5

The latest demand calls for 50,000 units, totaling the labor cost at $375,000-

$7.50 x 50,000 = $375,000

Depending on how long this project is estimated to last, management can break the total labor cost down into monthly budgets. If the company wants to produce 10,000 units per month, their monthly direct labor budget would be $75,000-

10,000 x $7.5 = $75,000

How a Direct Labor Budget Enhances Production Budgeting

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Establishing a direct budget enables companies to determine their staffing and funding needs to ensure a smooth workflow. It can also be used to forecast future demand and budgeting needs.

The information provided by a direct labor budget can be used to develop a production budget to estimate how many units the business needs to produce within a specific timeframe. Direct labor budgeting also enhances production budgeting by-

  • Estimating Product Needs
A production budget estimates how many units a company needs to produce to meet a quota based on previous sales, labor budgets, and forecasted demand.

Management can calculate the production benchmark by adding the projected sales and the ideal ending inventory. Then the actual beginning inventory is subtracted from this total to calculate the number of units that need to be manufactured.

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  • Determining Average Labor Cost
The direct labor cost is an estimate based on actual labor costs from previous projects. However, production budgeting calls for the average hourly labor cost, which can be calculated by adding hourly rates together and dividing the total by the number of employees. This can also be taken straight from the direct labor budget.

  • Estimating Labor Cost
The direct labor budget sometimes refers to the production budget to get a rough estimate of labor costs. This figure can be refined later by multiplying the unit quota by the labor cost per unit.

  • Forecasting Production
It is crucial to adapt forecasting methods when variances arise between actual and estimated sales.
When actual sales exceed forecasts, production may not meet the increased demand, voiding all calculated budgets and operation plans. Therefore, businesses should monitor market trends to update their budgeting estimates and forecast models.

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