What Are Direct Costs and How Do They Affect Your Business?

Not all business-related expenses are the same. They can be classified as indirect costs or direct costs, depending on how they are used. Direct costs are typically more important than indirect costs. What are direct costs, and how do they affect your business?

What Are Direct Costs?

Direct costs are business-related expenses that go towards a business’s money-making operations. They are known as “direct costs” because they are directly linked to products or services. Your business must spend money on goods or services so that it can sell its own products or services to customers.

Whether your business sells products or services, it will incur direct costs. Direct costs are expenses that are necessary for your business to sell its products or services. If your business manufactures products, for instance, it may incur direct costs like labor, machinery and utilities. Your business won’t be able to manufacture and sell its products without these direct costs.

Direct vs Indirect Costs

Indirect costs are business-related expenses as well, but they aren’t the same as direct costs. Direct costs are essential to your business’s money-making operations, whereas indirect costs are not. Rather, indirect costs are expenses that aren’t directly linked to products or services.

Another difference between direct costs and indirect costs is that only the former has a cost object. Cost objects are accounting items. They represent products, services, or in some cases, customers. When recording direct costs, you’ll need to associate them with a cost object. Each direct cost must be associated with a cost object. Indirect costs aren’t associated with a cost object. You can record indirect costs without worrying about cost objects.

Examples of indirect costs include:

  • Insurance
  • Marketing
  • Office Supplies

The Impact of Direct Costs

Like all business-related expenses, direct costs can impact your business’s cash flow. Cash flow is a measurement of money coming into and out of your business. As your business generates revenue, it will have to spend some of that money on direct costs.

There’s no way to avoid direct costs. All businesses will incur at least some direct costs. The good news is that there are ways to lower your business’s direct costs. If you’re spending too much money on wholesale products, for example, you may want to choose a different vendor. If you’re overpaying for machinery, you may be able to save money by purchasing used machinery rather than new machinery.

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