Direct labor costs are the wages, salaries, and benefits paid to employees who are directly involved in the production of goods or services.

Primary Implication

When sales decrease, do direct payroll costs decrease by a similar percentage?  If still no, you are turning a variable cost into a fixed cost for your business.  Allow this to happen too long, and you will see rabid profit erosion everytime you pay your direct workers to do work you won’t get paid for.

Overview

Direct Labor Costs are the direct worker wages paid associated with the manufacture of a product, a particular work order, or delivery of a service.  When possible, these costs should include direct labor benefits, payroll taxes, and worker’s comp insurance.  If you can’t easily segregate these additional payroll costs from the costs included in your SG&A salaries, then you must include them in your Overhead Absorption Rate if you can’t include them with your direct labor wages paid.

If sales decrease and your direct labor costs don’t drop proportionally, you are most likely “creating work” for your direct employees.  This means you are paying your direct workforce to do work you aren’t being paid to perform.  Every time you do this, you turn a variable cost into a fixed cost.  Do this for a very long time, and you will see a rapid erosion in your Gross Profit.  Never a wise move.