DIRECT VS INDIRECT COSTS

Understand the difference between direct and indirect costs

When preparing cash flow forecasts it is important to know the difference between direct and indirect costs. Here is a simple explanation with examples so you know what they are.

Direct / Variable costs

Direct (or variable) costs will vary according to the amount of products made.

As an example, a baker will need to use a specific amount of flour, eggs, sugar and other ingredients to make one cake.  If she needs to make 100 cakes, the amount of ingredients will rise in proportion.

So if the ingredients for one cake cost £5, the costs for making 100 cakes would be £500

(this is a general guide and of course does not take into consideration any reduction in getting a discount for ordering larger quantities of ingredients from the supplier)

Examples of Direct/Variable costs:

• Cost of Goods Sold
  • Materials and supplies
  • Packaging
• Direct Labour Costs
  • Customer service
  • Direct sales
  • Direct marketing
  • Delivery – fuel costs

Indirect / Fixed costs

Indirect (or fixed) costs remain the same no matter how many products are made.

The rent for the premises, telephone costs, insurance etc will still need to be paid at the same rate regardless of how many products are made.

It does not matter whether the baker makes one or 100 cakes, the fixed costs remain the same.

Examples of Indirect/Fixed costs:

• Rent
• Utility bills
• Phone bills/communication costs
• Accounting/bookkeeping
• Legal/insurance/licensing fees
• Postage
• Technology
• Advertising & marketing
• Salaries