• Labor costs go beyond wages to include overtime, benefits, and taxes. Understanding the full picture may help you forecast more accurately.
  • Payroll management is both an administrative task and a financial process. Accurate payments, tax compliance, and reporting protect margins and reduce risk.
  • Strategies such as forecasting, cross-training, and automation may help you align labor costs with revenue and improve your business’s long-term stability.

Payroll is often viewed as a back-office task, but for many small businesses, it’s one of the biggest levers shaping the company’s costs and cash flow. Labor typically represents the highest expense, and even minor errors may result in compliance penalties, cash flow disruption, or margin erosion.

By approaching payroll as a financial strategy rather than an administrative function, business owners may be able to improve cost control, strengthen forecasting, and build a foundation for sustainable growth.

Understanding the True Cost of Labor

Labor costs extend beyond wages to include overtime, payroll taxes, and employee benefits. Without visibility into these expenses, small and midsize businesses risk underestimating payroll and eroding profit margins. Let’s take a look at average labor costs across industries to better understand how they may be impacting your business.

Labor Costs in Healthcare

Healthcare providers typically spend more on labor than on any other expense, with wages and benefits often making up more than half of a hospital’s budget.[1] That share means every $1 million in revenue may require more than $500,000 to cover payroll alone, leaving less room to absorb rising costs in other areas.

Staffing shortages also continue to push wages higher and increase reliance on contract workers, who cost more than full-time employees. You may need to cover payroll expenses before reimbursement payments arrive, which can squeeze margins and add financial strain.

Moreover, healthcare organizations must also adhere to union contracts and state staffing regulations, which limit their flexibility. Using overtime may temporarily fill gaps, but it drives up costs and may lead to burnout, turnover, and increased expenses for hiring and training new staff.

Careful workforce planning, including balancing full-time and contract staff and aligning payroll with cash flow, may help control costs without sacrificing care quality.

Labor Costs in Retail

Labor in professional and business services often leans more heavily on benefits and incentive pay than in other industries. The Employment Cost Index tracks changes in the cost of wages and benefits over time. In Q2 2025, the index for professional services reached 174.2, indicating that compensation costs have increased by more than 74 percent since the index’s base year of 2005.[2]

This steady growth highlights how payroll in professional services continues to climb, even without large jumps in headcount. Because talent drives revenue in this sector, firms may feel pressure to offer higher pay and richer benefits.

Keeping an eye on how pay compares to revenue and how much of your total costs go to labor may help you protect profits while still offering competitive wages.

Labor Costs in Manufacturing

Manufacturing labor costs are closely tied to productivity. The unit labor cost index measures how much businesses spend on compensation for every unit of goods produced. In Q2 2025, the index reached nearly 133 (FRED), indicating that labor costs are approximately 33 percent higher than in the base year of 2017.[3] Rising costs may pressure margins, especially when productivity gains fail to keep pace.

At the same time, manufacturers face added financial strain from skilled labor shortages. Recruiting specialized workers often requires higher wages, while overtime increases costs further. 

If you’re considering automation to ease these pressures, weigh the upfront capital investment carefully against near-term payroll needs.

Labor Costs in Professional Services

In professional and business services, payroll often includes generous benefits and incentive pay to attract talent. In Q2 2025, the Employment Cost Index for professional services reached 165.1, indicating that compensation costs have increased by more than 65 percent since the index’s base year of 2005.[2]

For your firm, these steady increases may translate into rising payroll obligations even without major headcount growth. Because talent drives revenue in this sector, you may feel pressure to expand benefits or raise pay to stay competitive. Comparing compensation to billable revenue and monitoring labor as a share of expenses may help protect your margins.

Payroll Essentials Every Business Must Manage

Payroll involves more than cutting checks. To manage payroll costs and reduce risk, business owners need to stay on top of several essential responsibilities:

  • Accurate, timely payments: Paying employees correctly and on schedule helps build trust and avoid compliance issues. Even small errors may lead to disputes or penalties.
  • Tax withholding and remittance: Federal, state, and local taxes must be calculated and deposited accurately. Mistakes may trigger fines and complicate year-end reporting.
  • Benefit and deduction tracking: Health insurance, retirement contributions, and wage garnishments directly affect both paychecks and business budgets. In healthcare, where benefits account for a significant portion of compensation, accurate tracking is particularly crucial.
  • Payroll reporting: Regular reports make audits easier and show how much of your revenue goes to labor, helping with forecasts and spotting overspending.

Businesses that see these tasks as part of managing finances, and not just paperwork, may be able to protect profits and lower the long-term risk of cash flow or compliance issues.

How to Manage Labor Costs More Effectively

Labor is often your largest expense, which means even small inefficiencies may reduce profitability. By taking a structured approach to payroll, you may lower costs and gain better financial visibility. The following strategies outline practical approaches to align labor expenses with revenue.

Forecast Staffing Needs

When you match schedules to demand, you reduce unnecessary overtime and avoid paying for idle hours. In healthcare, that might mean balancing coverage with patient volumes. In retail, it could mean preparing for seasonal peaks.

Cross-Train Employees

Cross-training your staff gives you flexibility and helps you avoid costly overtime. It also keeps operations moving when someone leaves, limiting the financial hit of turnover.

Track Productivity Against Costs

Comparing payroll to output may reveal where staffing decisions positively or negatively impact profitability. If you’re in manufacturing, you might track unit labor costs. In professional services, the focus may be on billable hours.

Align Payroll with Cash Flow

Payroll rarely lines up neatly with revenue. In healthcare, you often pay staff weeks before insurance or government reimbursements arrive. By forecasting cash flow around payroll cycles, you may reduce strain and protect margins.

How Payroll Automation Improves Accuracy

Handling payroll manually takes extra time and increases the likelihood of mistakes. Using payroll software may cut those risks and give you a clearer view of labor costs. For growing businesses, automation also makes it easier to manage payroll as you add more employees.

Key benefits of automating your payroll include:

  • Fewer errors: Automated systems calculate wages, deductions, and taxes accurately, reducing the chance of disputes or penalties.
  • Time savings: Streamlining payroll frees up staff hours that may be directed toward financial planning or other priorities.
  • Better visibility: Integrated reporting tools provide clearer insights into payroll costs as a share of overall expenses, helping you make more informed decisions.

Payroll Compliance: Avoiding Costly Mistakes

Besides potentially frustrating employees, payroll errors may lead to financial penalties, audits, or even legal action. Staying compliant requires careful oversight across several areas:

  • Accurate worker classification: Misclassifying employees as independent contractors may result in back taxes, fines, and reputational damage.
  • Tax compliance: Federal, state, and local payroll taxes must be calculated and remitted on schedule. Mistakes may trigger costly penalties and added scrutiny.
  • Recordkeeping and audits: Maintaining complete payroll records supports audit readiness and helps you respond quickly to inquiries from tax authorities or regulators.

Connecting Payroll to Business Growth

Payroll plays a central role in your company’s financial performance. It may affect margins, cash flow, and long-term stability more than almost any other business expense. By understanding the full cost of labor and managing payroll with accuracy, you create a stronger foundation for financial planning.

Ready to align payroll with your financial strategy? Schedule with a PNC business banker to explore solutions that support cash flow, expense control, and growth.