Difference between direct & indirect expenses

 

Running a business is not easy. With the economy on a downward spiral, it has become even more challenging to make ends meet. Every penny spent needs to be turned over twice before it is paid out.

The goal of any business is to make money. Keeping tight reins on your business and the expenses incurred is vital. If you don’t, you could end up owing more than your actual income.

That is not a situation that any business longs to be in.

Profit is the name of the game, and one way of being ahead in this game is by using accounting software like ProfitBooks.

In this article, we’ll discuss direct and indirect expenses in the business. Read more to understand what is the difference between these two with some examples.

What Are Direct Expenses?

In short, a direct expense is an expense that is related to the purchase of products. Many companies are in the trade for resale, and they have to buy inventory to operate. Direct expenses would refer to anything related to what you have bought.

Companies that manufacture their products will assign the costs of materials to direct expenses.

Direct expenses that need to be considered in any business are very much the same throughout. The cost of materials, freight, and import duties are a few of these. These will all affect the cost of the products sold.

You do need to factor the cost of staff wages into the equation too. If you are a re-seller, the staff is an expense incurred as they are required to offload and pack the products that you are going to resell.

The staff that you hire for the manufacturing process makes the finished product possible. Their salaries become a part of the expenses against that product.

Certain areas of direct expenses will affect the price of products without a doubt. You may find that when fuel surcharges increase, so do the prices. This is a common occurrence and one that is unavoidable.

Companies can only carry the extra costs up to a point. Thereafter, they have no choice but to increase the sales costs.

What Are Indirect Expenses?

Indirect expenses are the costs incurred in the daily operation of a business. They are not related to the sold products.

In many instances, indirect expenses are not allocated to any area in particular.

This is most often true when it comes to administrative costs which may include rentals. Costs incurred that are factory overheads are direct expenses. These costs affect the products manufactured during the period the costs occurred.

At the end of the day, the cost inflates the price of the product at the time of sale. Examples of factory overhead expenses may include things like factory utilities and equipment.

Indirect expenses cannot be added to the cost of the product. It should not affect the sales price in any way.

Indirect expenses can also be subdivided into two categories – fixed indirect expenses and recurring indirect costs.

Fixed indirect expenses will refer to costs that are fixed for the duration of a project.

Recurring indirect costs refer to expenses that are paid on a repeat basis.

Indirect expenses, while necessary for the business to operate, cannot be traced back to the products.

Difference Between Direct And Indirect Expenses

To run a business successfully, you need to be able to keep a proper and correct financial history. That’s why it’s important to understand the difference between indirect and direct exposure.

Keeping your financial records in order assists your business to remain tax compliant as is required by law. It is vital to input your indirect expenses in the correct allocated places not only to maintain compliance but also to benefit from tax deductions.

Business owners do receive some perks and tax deductions for some indirect expenses. Certain indirect expenses such as your utilities which are required to keep your business going are subject to tax deductions. This rings especially true for business owners who operate from their homes.

It is imperative to know the distinction between the two types of expenses, especially when it comes to costing your products. If you fully understand the true costs of the production of the products, you can charge for your items more competitively.

Business is a hard nut to crack, but with the right tools in hand, you can be sure you will give your opponents a run for their money.

The accuracy of your financial records and the efficiency in the operation of your business will prove invaluable should the time come to attract investors.

Financial investors are more likely to outlay money to a company that is on top of its game and understands its business rather than throw it away on a whim with a company that shows no interest in keeping the correct records. Your financial records are a justification for a profitable business.

Also Read: How to separate personal & business finances

 

How Do Direct and Indirect Expenses Affect Your Product Costing?

The process of costing your products should include the indirect and direct expenses accrued in the production of a product.

Direct expenses can be directly traced back to a particular product or cost object. Raw materials and the cost of labor used during the manufacture of the product are good examples of direct expenses that are easily traced back to the product.

Depending on the business you run, wages or salaries may also be viewed as direct expenses.

Direct expenses are most often variable costs. These costs will fluctuate should you produce more or fewer products at any given time.

The direct expense will be about the quantities produced. In an instance like this, the raw materials would be a variable cost as the quantity would vary according to the production needs. A supervisor’s salary will not, however, be variable. In most cases, people in supervisor or management positions are paid a fixed monthly rate. The direct expense of the salary would, therefore, not be variable.

Direct materials and labor can be specifically traced back to a particular product. You will be able to account for the exact amount of raw material for each unit and the allocated labor costs spent to produce each unit.

Indirect expenses affect the business as a whole and not just a specific product. These ongoing operational costs are also referred to as overheads for the business.

Examples of indirect expenses may include office supplies, accounting services, and utility bills. Indirect expenses can also be fixed or variable. In instances like rental payments, the expense would usually be a fixed one. Your utility or telephone account would be a good example of a variable indirect expense as these fluctuate from month to month.

Indirect materials and labor such as tools make production possible, but they cannot be allocated to one product in particular. The costs of these materials are variable as they will change according to the workload.

The labor costs can be fixed or variable. If an employee is a manager who oversees the entire production plant and receives a fixed salary, then the indirect expense is fixed. However, if he/she is paid according to the hours worked or units produced, the indirect expense shall be variable.

 

No Expenses, No Business

It is essentially impossible to operate a business without accruing any expenses at all. The phrase, you have to spend money to make money, is true.

Indirect and direct expenses must be allocated correctly. This will especially stand you in good stead when the need to reduce production costs arises. You will easily be able to ascertain where cuts can be made.

The difference between a business that is making a profit and one that is just scraping by, according to the financial records and history, is how the bookkeeping is carried out.

Employing the services of a registered accountant who has a track record of efficiency and success is a sure-shot way of keeping your business’s paperwork in order and ready for your tax submissions. The absolute last thing you want to do is raise alarm bells and set your company up for an audit.

One fundamental reason to allocate your direct and indirect expenses correctly is the simple fact that some indirect expenses are tax deductible. Doing things in the right way will allow you to benefit from them later.

If you want to run a professional operation, you need to carry out your affairs in a professional manner. Keeping your nose clean and declaring all your financials with honesty will keep your business out of the red. The ability to cost your products in line with the industry and at a competitive rate will allow you to achieve success and profit.

 

How ProfitBooks Can Help

The best way to analyze something is by keeping a strict record of it. You can do it with spreadsheets, but as your business increases it might get tedious to maintain.
ProfitBooks is an accounting software with business owners in mind, this software will help you not only keep track of direct and indirect expenses but also with all your accounting needs like inventory, invoices, etc.

Visit the ProfitBook website and register for a free startup account.

Try ProfitBooks Free Now

FAQs

Can indirect expenses be directly attributed to a specific product or project?

No, indirect expenses cannot be directly attributed to a specific product or project. They are incurred to support the overall operations of the business rather than being directly linked to a particular undertaking. Indirect expenses are shared across different areas or departments of the organization.

How do direct and indirect expenses impact the profitability of a business?

Direct expenses directly impact the cost of goods sold (COGS) and, consequently, the gross profit of a business. Indirect expenses, on the other hand, affect the operating expenses, which are deducted from the gross profit to determine the net profit. Both types of expenses influence the overall profitability of the business.

 

Can indirect expenses change over time?

Yes, indirect expenses can change over time due to various factors. Examples of such factors include fluctuations in utility costs, rent increases, changes in administrative salaries, or variations in the usage of shared resources. It’s essential for businesses to regularly review and monitor their indirect expenses to manage costs effectively.

 

Are all overhead expenses considered indirect expenses?

Yes, overhead expenses are generally categorized as indirect expenses. Overhead expenses encompass various costs required to maintain the business’s overall functioning, including rent, utilities, salaries of non-production staff, office supplies, and maintenance expenses. These costs are not directly attributable to specific projects or products.

 

How can a business control indirect expenses?

Businesses can implement several strategies to control indirect expenses. This includes carefully monitoring and analyzing overhead costs, negotiating favorable contracts with vendors, implementing energy-saving measures to reduce utility expenses, optimizing resource allocation, and adopting efficient administrative processes. Regular budget reviews and cost-conscious decision-making can help businesses effectively manage and control their indirect expenses.

Also, read

How To Generate E way Bill on GST Portal – 5 Easy Steps
What is Cloud Accounting, And How it Will Help Your Business
Credit Guarantee Scheme, Ultimate Loan Scheme in 2023.