Knowing the difference between direct costs and indirect costs don’t seem that interesting to most people, but when you’re a business owner it means a lot. In accounting and managing your businesses money the difference becomes very important. So, what are the differences?
Let’s start with direct costs. Direct cost can be traced to a specific product, good or service. Direct costs are often attached to a “cost object” with expenses being directly linked to it. A cost object can be a product, department or project.
Direct costs can include labor and direct materials which are used in creating a specific product. Software development can involve direct costs like specific pregenerated assets such as development applications and purchased frameworks. Steel, electronic components and other raw material used for the construction of specific products are direct costs.
Direct costs are variable because they are often tied to product runs or increases and decreases in production. As an example, smartphone hardware is a direct cost because its production depends on the number of units sold.
Indirect costs are a little different. Indirect costs go beyond the expenses associated with the creation of a particular product. Indirect costs are involved with what it cost to maintain the entire company. This is often called overhead or the cost of doing business. These costs are the ones left over after direct costs have been computed.
Indirect costs can also include the materials and supplies needed for the company’s day to day operations. Items like cleaning supplies, utilities, office equipment rental, computers and phones. These are the types of items that are not specific to a particular product but are needed for the company to function as a whole.
Indirect costs can be both fixed and variable. Utilities can be variable depending on usage, while the rent paid for a building can be fixed for a term. Keeping direct and indirect costs separate can be critical to an accurate budget. If you’re still not sure what category to assign certain costs, consult with a professional.