In manufacturing companies, there is a wide variety of positions and professional profiles (unskilled and skilled): operators, forklift drivers, engineers, quality auditors, HR specialists… In this post, we will focus on how these positions can be classified from a cost perspective and where they are allocated in the profit and loss statement (P&L).
Essentially, labor can be categorized into three types: Direct Labor (DL), Indirect Labor (IL), and Staff.
Table of Contents
Direct Labor (DL)
Direct labor refers to all employees who work directly in the manufacturing process, such as a welding line operator.
Direct labor is always a variable cost. Generally, a higher level of production will require hiring additional workers in direct labor positions, resulting in higher expenses. Conversely, if production decreases and no external factors (such as trade unions or labor market conditions) are involved, the company should be able to adjust the headcount to match the lower level of production.
Indirect Labor (IL)
It includes employees who:
- Supervise the manufacturing process (-e.g., production line leader).
- Work in auxiliary departments to production (-e.g., quality auditors, maintenance technicians).
Indirect labor can be classified as either variable or fixed cost, depending on its relationship with the level of production. If additional workers are needed in a specific position to increase production, this labor is considered variable. On the other hand, if the number of employees remains constant regardless of production levels, it is considered fixed. In my experience, most indirect labor is variable.
Staff
Staff costs are always fixed and refers to workers within these categories:
- Management positions in production or auxiliary departments -e.g., production manager, logistic manager.
- All personnel in administrative departments -e.g., sales, purchasing, HR, finance.
Labor costs in the P&L
| Sales |
| – Cost of good sold |
| = GROSS PROFIT |
| – Variable labor (Direct + Indirect variable) |
| – Variable overhead |
| = CONTRIBUTION MARGIN |
| – Fixed labor (Staff + Indirect fixed) |
| – Fixed overhead |
| = EBITDA |
As shown, variable labor and fixed labor are allocated before and after the contribution margin, respectively. Proper classification of all company positions is crucial for understanding which costs can be adjusted (and which cannot) in response to changes in production levels. Furthermore, accurate classification is essential for reliable budgeting and forecasting, as variable costs often depend on production planning.
Summary
| Type of labor | Nature of cost | Example |
| Direct labor (DL) | Variable | Operator |
| Indirect labor (IL) | Variable of fixed | Production line leader, quality auditor |
| Staff | Fixed | Industrial director, IT technician |
