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Opportunity cost, a costing input and a recorded wage — the same hours answering three different questions, and never two in one calculation.
Paper packet. Every task here also exists on screen, where it is checked automatically; answers written on paper are not assessed by Nydus. When you are back at a device, enter your answers there.
You will take any statement about an owner's own work and say which of three things it means: the best alternative those hours gave up, an hourly rate applied to the hours inside a unit, or a wage recorded in the accounts — which exists only where the legal form allows one. You will work out each figure, say which of the three belongs in a price, and show what breaks when two are used at once.
Lesson 3 put the owner's hours at a rate into a batch without saying where that rate came from or what else the same hours might mean. This lesson pays that debt. You already know how to cost a batch and why leaving a line out makes every price short; the owner's hours are the line most often left out, and the one most often put in twice.
| Term | What it means |
|---|---|
| Opportunity cost | What the owner gives up by working here: the hours times the best wage actually available elsewhere. |
| Costing rate | The hourly rate an owner applies to the hours inside a unit, so the price covers the work. |
| Costing input | The costing rate times the hours one unit takes: labor in the unit. |
| Accounting expense | A cost recorded in the accounts; an owner's wage appears here only where the legal form allows one. |
| Drawings | Money an owner takes out of a business whose form treats it as a share of profit, not as a wage. |
| Sole proprietor | A business owned by one person with no separate legal form; the owner takes drawings, not a salary. |
| Company | A corporation, or an LLC taxed as one: a business with its own legal identity that can employ its owner and record a salary. |
Owner labor is three different things, and every lesson that touches it says which one it means.
| Sense | What it is | The question it answers |
|---|---|---|
| Opportunity cost | what the owner gives up by working here rather than somewhere else | Is this business worth the owner's time at all? |
| Costing input | an hourly rate applied to the hours a unit takes, so the price covers the work in it | What does this unit cost to make and sell? |
| Accounting expense | a wage recorded in the accounts, which happens only where the legal and accounting form of the business treats the owner's pay as an expense rather than as drawings from profit | What do the statements show? |
The first two are always available and always used. The third depends on where the business is and what form it takes, so anything that asserts it names both.
Nothing is double counted, because no two of them ever enter the same calculation. The trouble starts when one is used where another belongs — most often the second mistaken for the third, which is why a break-even and a profit-and-loss stop agreeing.
Another way: table
Maya works 35 hours a week, could earn 16 an hour elsewhere, costs her time at 27 for pricing, and is a sole proprietor. In dollars:
| Sense | Figure | Where it is used |
|---|---|---|
| Opportunity cost | 560 a week | deciding whether to keep going |
| Costing input | 18 in a bowl | setting the price of a bowl |
| Accounting expense | 0 | the profit and loss |
Three numbers about the same hands. The third is zero because of her legal form and would be a salary if she incorporated — while the middle number would not move a cent.
Another way: steps
When a sentence mentions the owner's time:
Name the question first. Before any number, write the question the figure has to answer. A sentence like my time is worth 25 an hour is not yet a figure in any sense; it becomes one only when you say whether it is being used to decide, to price or to record.
For stay or go, use the best real alternative. The outside wage is what a job you could actually get would pay, for the hours you actually work — not the salary of a job you would like. Multiply by the hours: 30 hours at 19 is 570 a week. Compare that with what the business earns for the owner over the same week.
For a price, use a costing rate on the unit's hours. Turn minutes into hours by dividing by 60, then multiply by the costing rate: 45 minutes at 28 an hour is 0.75 × 28 = 21. This figure goes into the unit cost next to materials and the overhead share.
For the accounts, look up the legal form. A corporation can employ its owner and record a salary; a sole proprietor cannot, and takes drawings from profit instead. The statements show whatever the form allows.
Keep each figure in its own calculation. Three checks catch the common mistakes. If a price contains the outside wage, the stay-or-go figure has leaked into the price. If a break-even contains both a costing input in each unit and a salary in the fixed costs, the same hours are charged twice. And if a profit-and-loss for a sole proprietor shows an owner wage, the form has been misread.
The costing rate is a decision, and there is no single right number. Three reasonable starting points are common. The replacement rate is what it would cost to pay someone else to do the same hours, including the extras an employer pays on top of a wage. The target rate is what the owner needs each working hour to earn to cover a living, once the hours that cannot be charged — admin, travel, quoting — are allowed for. The market rate is what others doing similar work charge for their time.
Whatever the choice, write it down and use it consistently: a rate that changes from job to job is not a costing rate but a guess. It is usually higher than the outside wage, because only some of an owner's hours can be charged to a unit, and those hours have to carry the rest. That is why Maya's costing rate of 27 sits above the 16 she could earn elsewhere, and there is nothing inconsistent about it: the two figures answer different questions.
Review the rate once a year, or whenever the chargeable share of the week changes. An owner who takes on a part-time helper for the admin can charge more of her own hours to units, and her costing rate can fall without her income falling; one who spends more time selling needs it to rise.
Taxes, permits, registration and the records a business must keep are set where the business trades, and they differ from one place to the next and from one year to the next. So this teaches the reasoning — what a figure is for, and how to work it out — with any rate or threshold given to you in the question as a number to use. The rate that applies to you is a thing to look up with the authority where you trade, and to check again each year.
What the legal form changes is the third sense only. A sole proprietor's profit is the owner's income, and any money taken out is drawings; a company's owner can be an employee, and a salary then appears as an expense before profit. Move the same business from one form to the other and the accounts change shape. The costing input does not: a repair still takes 45 minutes and the price still has to carry them. Nor does the opportunity cost: the outside job pays the same whatever form this business takes.
A web designer left a salaried job paying the equivalent of 32 dollars an hour to work for herself. She works about 40 hours a week, but only around 25 of them are on client projects; the rest go on finding work, quoting, invoicing and keeping her skills current. Her opportunity cost is the old job: 40 × 32 = 1,280 a week. If her business does not clear that over a normal month, the arithmetic says the old job was the better deal, however much she prefers the freedom — and that preference is hers to weigh.
Her costing rate has to be higher than 32, because 25 chargeable hours must carry a week's income. To match 1,280 from 25 hours she needs 51.20 an hour before any software or equipment, and she uses 60. A small site she expects to take 30 hours therefore carries 30 × 60 = 1,800 of labor in its quote.
In her first year she is a sole proprietor, so her accounts show no wage at all: the site's profit is her income and she takes drawings. When she later forms a company on her accountant's advice and pays herself a salary, her accounts gain a wage line, and her quotes do not change by a cent. Thirty hours of work still take thirty hours.
Surveys of small firms regularly find owners who cannot say what their own hour is worth in the business, and many price from materials and a sense of what customers will pay. The result is familiar: a business that looks profitable on paper and pays its owner less than the minimum wage once the hours are counted. Naming the three senses — and putting the second into every unit cost — is the cheapest correction available.
My time is free. It is the largest cost in most small businesses. Leave it out and every price is short by the whole of it, and the business looks profitable while paying its owner nothing.
The costing rate is the wage I pay myself. Different questions, usually different numbers. The costing rate covers the hours in a unit; what you take out depends on what the business can afford.
The accounts prove I have no labor cost. A sole proprietor's accounts show no owner wage because no wage exists to record. That is about the legal form, and says nothing about what a mug costs to make.
Adding opportunity cost to the price. It is not a cost of the unit but the bar the whole business must clear. Put it in a price and the same hours are in there twice.
Ask whether she should keep doing this: 30 hours a week at the 19 she could earn elsewhere.
$30 \times 19 = 570$
Opportunity cost answers stay or go, for the whole week.
Ask what one clean costs in labor: ninety minutes at her costing rate of 24.
$90 \div 60 = 1.5; \quad 1.5 \times 24 = 36$
The costing input goes into the price of one clean.
Add the 7 dollars of materials to cost the clean.
$36 + 7 = 43$
Labor sits beside materials in the unit cost.
Ask what the statements show: she is a sole proprietor.
$\text{wage expense} = 0$
Her drawings come out of profit and are not a wage.
Compare a week that clears 700 dollars with the bar.
$700 > 570$
The business beats the alternative, using the first figure and neither of the others.
Write what Maya needs from the business in a year.
$\text{target} = 28\,000$
The costing rate starts from what the hours have to earn.
Count her working hours in a year: 35 a week for 46 weeks.
$35 \times 46 = 1610$
Holidays and sick days are hours that earn nothing.
Estimate the share that can be charged to pots: about two-thirds.
$1610 \times \tfrac{2}{3} \approx 1073$
Selling, packing and admin are real work that no single pot carries.
Divide the target by the chargeable hours.
$28\,000 \div 1073 \approx 26.10$
The chargeable hours have to carry the whole target.
Round up to a working rate.
$\text{costing rate} = 27$
A round figure used consistently beats an exact one used once.
Compare it with her outside wage of 16.
$27 > 16$
The two rates answer different questions, so they need not be equal.
Northside Repairs costs the owner's 45 minutes a job at 28 an hour.
$0.75 \times 28 = 21 \text{ a job}$
This is a costing input, carried by every repair.
The business is a company and pays him a salary of 2000 a month, in fixed costs.
$\text{fixed costs include } 2000$
This is an accounting expense.
He does about 95 repairs a month. Find the labor charged through the jobs.
$95 \times 21 = 1995$
The jobs already carry almost the whole salary.
Add the salary in fixed costs as well.
$1995 + 2000 = 3995$
The same hours are now charged twice.
Say what this does to break-even.
$\text{fixed too high and contribution too low}$
Both halves of break-even are wrong in the direction that makes it look worse.
Choose one treatment: jobs carry his time, and the salary leaves fixed costs.
$\text{fixed} - 2000; \quad 21 \text{ stays in each job}$
Either treatment is fine alone.
Write down which treatment was used.
$\text{owner labor: costing input, not in fixed}$
Saying which sense is in play is what keeps the calculation honest.
He could earn 22 an hour at a garage and works 40 hours a week. Find the bar the shop must clear.
$40 \times 22 = 880$
Opportunity cost: hours times the outside wage.
A service takes 60 minutes and he costs his time at 30. Find the labor in one service.
$1 \times 30 = 30$
Costing input: the unit's hours times the costing rate.
He is a sole proprietor. Find the wage in his accounts.
Three decisions at three businesses. Match each to the sense of owner labor it is using.
| Opportunity cost — the best forgone alternative | A costing input — a rate applied to the hours in a unit | An accounting expense — a wage recorded in the books | |
|---|---|---|---|
| Monica turns down $20$ dollars an hour elsewhere to run the stall, and asks whether the stall is worth it | |||
| Maya puts fifteen minutes of her own time into the cost of a mug before setting its price | |||
| Northside Repairs shows the owner's salary as a line in its profit and loss |
Complete the worked solution: an owner works $31$ hours a week, could earn $18$ dollars an hour elsewhere, costs her time at $28$ dollars an hour, and a job takes $75$ minutes. She is a sole proprietor. Give the three figures.
Multiply the week's hours by the outside wage.
$31 \times 18 =$ p
This is the opportunity cost of a week: what the hours could earn elsewhere.
Turn the job's minutes into hours.
$75 \div 60 = 1.25$
The costing rate is per hour.
Apply the costing rate to the job's hours.
$1.25 \times 28 =$ c
This is the labor in one job, which goes into its price.
Write the wage the accounts record.
$\text{wage expense} =$ e
A sole proprietor's drawings are a share of profit, not a wage.
Say where each figure is used.
$\text{week} \to \text{stay or go}; \quad \text{job} \to \text{price}$
Using one where another belongs is what breaks a calculation.
The owner of Monica's Market Stall works $40$ hours a week in the business. The best job actually open to her pays $14$ dollars an hour. What does a week in the business cost her in forgone earnings, in dollars?
Answer:
Here, Northside Repairs is a company in its jurisdiction and pays its owner a salary, which appears as a line in the profit and loss. Which sense of owner labor is this, and what makes it available?
At Maya's Ceramics, throwing and trimming one bowl takes $45$ minutes of the owner's time. She costs her time at $24$ dollars an hour for pricing, and could earn $16$ an hour elsewhere. How many dollars of labor should the price of the job carry?
Answer:
A dog groomer, a sole proprietor, works $26$ hours a week and her business made $696$ dollars of profit last week, which she can take as drawings. The best job open to her pays $20$ dollars an hour. By how many dollars did the week beat the alternative?
Answer:
A freelance translator turned down an in-house post paying $22$ dollars an hour. She costs her own time at $32$ dollars an hour when quoting, and a document takes $8$ hours. She is a sole proprietor. How many dollars of her labor belong in the quote for that document?
| Amount | |
|---|---|
| The document's hours at the in-house rate, dollars | |
| Labor for the quote at her costing rate, dollars |
Lesson test: one question per skill, one attempt each, no hints. Your answers are checked when you submit.
At Bright Home Cleaning the owner works $30$ hours a week, could earn $19$ dollars an hour elsewhere, and costs her own time at $24$ dollars an hour when working out what a job costs. A single job, a standard two-room clean, takes $90$ minutes. The business is a sole proprietor, so what the owner takes out is drawings from profit. Give all three figures, in dollars.
| Dollars | |
|---|---|
| Opportunity cost of one week, at 19 an hour | |
| Costing input in that one job, at 24 an hour | |
| Wage expense in the accounts of a sole proprietor |
You can name the three senses of owner labor, work out each, and say which question each answers. Tell someone why a sole proprietor's accounts showing no owner wage does not mean the owner's time is free. Next: putting the second sense to work, as an hourly rate inside a unit.
14. Your turn: the owner of a bike repair shop, step 3
$\text{wage expense} = 0$
The legal form allows drawings, not a wage.