the rate of indirect cost allocation to direct cost of either labor or inventory to give a better picture of the cost of producing and selling a product or delivering a service.
Burn Rate Details
Burn rate is the rate of allocation of the hidden labor and inventory overhead costs to direct costs. You can calculate this by adding the burden cost to direct costs to present the total absorbed cost of the items. Many indirect costs are associated with running a business; these costs are not always visible initially, but they come along the line and can confuse a business owner. These costs contribute to the company’s direct costs directly into your product or service production and delivery cost.
Your direct costs will significantly affect your gross profit because it usually appears in your income statement. But don’t forget the fact that your business uses indirect costs to keep running, and those costs can either increase or decrease your net profit. Therefore, knowing the burden rate for a particular project will help you to manage your project’s cost-effectiveness. It will also help you to do projects with high value and at reasonable costs, which will help you produce a high profit on that project.
Imagine you own a business. You will have sales and marketing people as members of staff. Apart from staff salaries, you incur some costs that you then bill to your clients. Your company incurs other costs for every staff member, like payroll taxes, insurance, and others, depending on its size and profitability. All these additional costs are what make up the total labor burden cost of employing staff.
Burn Rate Example
Let’s assume you have a company where you pay your marketing staff $60,000 and pay your sales staff $40,000 per annum. The annual tax and other benefits that you pay your marketing staff are $23,000, and that of the sales staff is $20,000. How do you calculate the labor burden rate for both the marketing and the sales staff?
To calculate the labor burden rate, use the labor burden rate formula: Labor burden rate = Labor Burden Cost/Total Labor Cost. The labor burden rate for the marketing staff is calculated as: Labor burden = $23,000/ $60,000 = $0.383. The labor burden rate for the sales staff is calculated as: Labor burden = $20,000/$40,000 = $0.5
From the above calculation, you can see that you have incurred $0.38 overhead cost for every dollar of salary you pay to your marketing staff and $0.5 overhead for every dollar you pay to your sales staff.
Importance of Burn Rate
Burn rate helps in decision making; it helps you organization decide if it should continue certain activities by considering the direct and indirect costs and the net profit.
Knowing the burn rate also helps your company have a clearer picture of its finances by exposing many of its hidden costs and helps determine the minimum selling price for your product or service after considering both the inventory burden cost and the labor burden cost.