Blog Layout

Direct vs. Indirect Costs (and Why You Should Care)

Linda Weathers • Aug 12, 2021

If you’re a business owner who wants to continually find ways to increase your profitability, then you’ll want to learn about direct and indirect costs. Breaking out your expenses into direct and indirect categories can help you arrive at the most profitable volume of sales for your business.

Direct Expenses

Expenses that fall into the direct cost category are ones that relate directly to the items you sell. Here are some examples.

  • If you have a flower shop, the cost of the flowers is a direct cost. So is the cost of vases, ribbons, cards, and the labor to put the arrangements together.
  • If you are a law firm, the labor and any materials or supplies spent on serving a client is a direct cost.
  • If you own a pool building company, the costs of the concrete, tiles, filter, pump, and labor to build the pool are direct costs.
  • If you run a toy store, the purchase of the toys is a direct cost.

Direct expenses, unlike indirect expenses, will vary proportionally to the volume of items you sell. The more you sell, the higher your direct expenses. The less you sell, the lower your direct expenses.

In general, direct expenses should be recorded in Cost of Goods Sold. You can get your Gross Profit figure by calculating Sales less Cost of Goods Sold (or COGS). Gross Profit Margin is an important percentage to know in your business. It is computed as follows: (Sales – COGS) / Sales.

Some small service companies might not bother to break out labor into direct and indirect on the Profit and Loss statement each month, but it can be useful to break out periodically or when you are re-evaluating your pricing and profitability.

Direct expenses are important in making pricing decisions, but so are indirect expenses.

Indirect Expenses

Indirect expenses are expenses that you need to incur to run your business, but are not directly related to the items you sell.  Here are some examples:

  • Telephone
  • Rent
  • Insurance
  • Utilities such as electricity, gas, water, and garbage pickup
  • Administrative labor, such as a receptionist or supervisor
  • Education and training
  • Professional services, such as legal, HR, IT, or accounting
  • Office supplies
  • Hardware and software
  • Business permits

Fixed and Variable Costs

Direct and indirect costs can each be further broken down into fixed and variable costs. For example, HR expenses, education, and training will go up as you sell more and hire more workers. That makes them variable costs.

Other indirect expenses will remain flat no matter what your sales volume is, such as rent. That means they are fixed costs.

Pricing Your Items

When calculating your sales prices, use direct costs to be sure your profit margin is high enough to cover an allocation of your indirect expenses.  In other words, sales price should always cover all direct costs plus a profit component, plus enough to cover indirect costs when considering the volume of your sales.

The lower your sales volume, the higher the price per item should be. A higher sales volume gives you more room to spread out your indirect costs over more sales. That leads to either higher profits, or you can lower your price to be more competitive.

If you have questions about direct and indirect costs or want help validating your pricing decisions, please feel free to reach out any time.

By Linda Weathers 15 Jun, 2023
We’re six days away from the first day of summer, and a few weeks away from the midpoint of the year. It’s the perfect time for taking a strategy check in your business to see how you’re doing for the first half of 2023 as well as to plan something fun and productive for summertime.   […] The post Five Summertime Strategies for 2023 first appeared on .
By Linda Weathers 12 Jun, 2023
We’re six days away from the first day of summer, and a few weeks away from the midpoint of the year. It’s the perfect time for taking a strategy check in your business to see how you’re doing for the first half of 2023 as well as to plan something fun and productive for summertime.   […] The post Five Summertime Strategies for 2023 first appeared on .
By Linda Weathers 05 Jun, 2023
The topic of artificial intelligence (AI) has been in the news quite a bit recently, and one of the reasons is the launch of an AI chatbot called ChatGPT. The GPT in ChatGPT stands for generative pre-trained transformer, which is a program that can realistically write like a human and interact in a conversational way. […] The post Cool Tech Tools: ChatGPT first appeared on .
By Linda Weathers 01 Jun, 2023
The topic of artificial intelligence (AI) has been in the news quite a bit recently, and one of the reasons is the launch of an AI chatbot called ChatGPT. The GPT in ChatGPT stands for generative pre-trained transformer, which is a program that can realistically write like a human and interact in a conversational way. […] The post Cool Tech Tools: ChatGPT first appeared on .
By Linda Weathers 12 May, 2023
In the last few years, the shortage of accounting professionals has grown tremendously, and many business owners are struggling to find reputable, quality accounting services. Prices for accounting services may have gone up due to this supply/demand imbalance, and they will keep going up for years to come– due to the shortage in accounting graduates […] The post 5 Ways to an Accountant’s Heart first appeared on .
By Linda Weathers 28 Apr, 2023
Being in business means taking a lot of risks, especially financially, and as an entrepreneur, you deserve to be rewarded for those risks. Your pay is just one of the many benefits of your self-employment. But it’s not like the pay you get as an employee; it needs to be more comprehensive than that.   Getting […] The post Don’t Shortchange Yourself: What an Entrepreneur’s Pay Should Cover first appeared on .
By Linda Weathers 20 Apr, 2023
For taxpayers collecting payments through a third-party payment platform (such as PayPal), the American Rescue Plan Act (the “Act”) established a major change to tax reporting rules to prevent businesses and contractors from hiding income through the receipt of electronic payments. Form 1099-K is the tax form issued by credit card companies and third-party payment […] The post 1099-K Reporting Changes first appeared on .
By Linda Weathers 20 Apr, 2023
Drones were considered fun when they first came out, but they are far from toys. Drones have surprising benefits with extremely high return on investment to certain business owners. A drone is a robot that can fly and that is controlled by a remote device. The technology includes GPS (global positioning system) and built-in sensors. […] The post Cool Tech Tools: Drones first appeared on .
By Linda Weathers 06 Apr, 2023
While spring brings a change in the weather for most locations, it also brings a number of opportunities to refresh your products and services. Spring is a great time to boost your marketing campaigns so that you can boost your business revenues. Adding the theme of spring to your marketing campaigns allows customers to see […] The post 6 Ideas to Put the Spring into Your Spring Revenue first appeared on .
By Linda Weathers 23 Mar, 2023
If you have accumulated more money in your business checking account than you really need for daily operating expenses, that is a nice problem to have! It’s time to consider putting that money to work. A business savings account might be your answer. Every bank is different when it comes to the features and benefits […] The post Do You Need a Business Savings Account? first appeared on .
More Posts
Share by: