If you’re a business owner, keeping track of your indirect costs is vital. If you don’t, you may not have a wholly accurate picture of your company’s production costs. That’s why the burden rate formula is so useful.
Find out how to do a burden rate calculation with our short, simple guide. First off, let’s answer the question running through your mind right now: what is a burden rate?
Burden rate definition
There are two types of costs associated with running a business: direct costs (costs that contribute directly to the delivery of your product or service, such as equipment maintenance) and indirect costs (costs that are used by multiple activities and cannot be assigned to specific cost objects).
Burden rate helps you to compare your company’s indirect costs with your direct costs. This provides you with a much more accurate picture of the cost of producing/delivering a product or service, which enables you to make better decisions regarding production or labor.
What is the burden rate formula?
Typically, the burden rate formula is used to find out the indirect costs associated with labor or inventory.
Here’s the labor burden rate formula:
Labor Burden Rate = Indirect Costs / Direct Payroll Costs
Essentially, you’ll need to total up all your indirect costs, which can include anything from paid time off and health insurance to employment taxes. Then, to determine the labor burden rate, you’ll simply divide the indirect costs by the direct payroll costs.
And here’s the inventory burden rate formula:
Inventory Burden Rate = Material Expenses / Production Total
To work out the inventory burden rate, you’ll need to know how much you spend on material expenses (sometimes referred to as overhead costs) when producing a product/service.
Then, you need to calculate the production total that the material expenses are for. For example, if you have a machine that can make 100 of your products in one hour, and the machine is run for eight hours a day, five days a week, your production total would amount to 208,000 (100 x 8 x 5 x 52). To work out the inventory burden rate, you simply divide your material expenses by the production total.
What are the advantages of doing a burden rate calculation?
Put simply, burden rate gives you a better understanding of your business’s production costs. Remember, if you’re not accounting for indirect costs, you’re unlikely to have a clear sense of whether your company is overspending. A burden rate calculation can help you to make better managerial decisions regarding your business, especially if you have highly variable indirect costs.
For example, understanding your labor burden rate can give you a more accurate insight into how much your employees are costing you. This can help you to determine whether you’re able to afford specific employee benefits, or whether your production costs simply don’t allow for these kinds of expenses.
Burden rate vs. overhead rate explained
In some cases, business owners conflate overhead rate with burden rate, but there are a couple of important distinctions that you need to bear in mind. Essentially, overheads refer to ongoing expenses, including marketing costs, licenses and permits, office equipment, and so on. Importantly, overheads are not directly linked to the cost of production.
Burden rate, however, is used to help determine the true cost of production. So, while both burden and overhead rate are important for budgeting, when it comes to burden rate vs. overhead rate, you should remember that overhead rate considers costs outside of those incurred during the production/delivery of goods and services.
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