This year there have been thousands of businesses started up across the globe as people pivot their career paths in response to the COVID pandemic.
Understanding Your Outgoings on Direct and Indirect Costs
But if you’ve never run a business before, there are a few important things you might need to understand that you wouldn’t have necessarily come across unless you have a business degree.
For example, when starting a business, it’s important to understand your costs – both direct and indirect. What is the difference between the two? Allow us to elaborate.
The Importance of Costs/Outgoings for a Start-up and Business in General
Without keeping track of your costs it’s impossible to make informed business decisions like setting accurate prices. Costing is one of the more complex and multifaceted aspects of any business and the foundation of your costing process should always be keeping tabs on your outgoings.
Before you can sort your direct from your indirect costs you need to define your cost objects. These could be anything from a product or service to your employees. Make a list of everything that costs your business anything and then you’ll be able to dig deeper into whether those costs are direct or indirect.
Direct Costs
Your direct costs refer to any expense that can be directly connected to a cost object. So, the labor cost of your employees is a direct cost, as are the vast majority of material costs. If you’re in the business of manufacturing, for example, then you’ll need raw materials and all of these materials will be direct costs. If you are a retailer, meanwhile, your stock will constitute a direct cost.
Indirect Costs
On the contrary, an indirect cost is a cost that can’t be linked directly to a cost object. For example, replacement car tyres for company vehicles can be considered an indirect cost because maintenance isn’t a direct contributor to the product or service you’re supplying.
Why Is It Important to Differentiate?
Ultimately, understanding the difference between indirect and direct costs will give you a deeper understanding of your business and will allow you to experiment with more competitive pricing. It also means your accounting will be significantly improved, so you’ll be able to make more accurate predictions for the future.
When it’s time to file your annual tax return, meanwhile, it will also help you to understand which costs are deductible and which are not so you could end up saving a small fortune that way. Of course, every business will have a slightly different situation and it’s always a good idea to hire an accountant to make sure but if you have at least a basic understanding of your costs then you are far more likely to make better decisions.
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