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, after all, is to make money. Keeping tight reigns 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.
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 bulk stock to operate. Direct expenses would refer to anything that is related to what you have bought.
Companies that manufacture their own 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 costing 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 make the finished product possible. Their salaries become a part of the expenses against that product.
There are certain areas of direct expenses that 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 which 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 proper and correct financial history. That’s why it’s important to understand the difference between indirect and direct expesnse.
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 correctly 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 who is on top of their game and understands their 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 is one that 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 labour 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 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 labour 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 labour 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 material and labour such as tools make the production possible, but they cannot be allocated to one product in particular. The costs of these materials are variable as it will change according to the workload.
The labour 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.
It is vital that indirect and direct expenses are 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 a 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 a profit.
How ProfitBooks Can Help
ProfitBooks is a popular bookkeeping software that makes recording expenses super easy. You can record inventory purchases and business expenses separately so that these two don’t mix up.
Apart from this, ProfitBooks also make billing painless. You can try the software free for 2 weeks.Try ProfitBooks Free Now