Direct Costs vs Indirect Costs

In the business world, financial management is very important. One aspect that must be considered carefully is the cost. The costs incurred by the company can be divided into various categories, namely direct costs and indirect costs. Come on, get to know the definitions, examples to the differences between the two.

What are Direct Costs?

Direct costs are those that a company can easily attribute to a specific "cost object," which can be a product, a department, or a project.

Typically, this cost category includes everything related to the production or development of a product, including software, equipment, raw materials, and labor specifically involved in the production of a particular product or project.

For example, when an employee works exclusively for a project or spends his working time on the project for a certain number of hours, the wages paid to him for that project will be considered a direct cost.

Likewise, when a company develops software and has to purchase certain assets such as a development framework or application, all these costs will be considered as direct costs.

Example of Direct Cost

Some of the most common examples of direct costs are labor and direct materials. For example, in the process of creating a product such as an electronic device, manufacturers need various components, steel and other raw materials. Expenditures for all of these materials are considered as direct costs.

Approaches to tracking these costs may vary depending on company policies. Two popular methods used are the first-in, first-out (FIFO) and last-in, first-out (LIFO) methods.

The use of the LIFO method is useful when the costs of these materials fluctuate during the production process. Although most direct costs are variable, there is an important exception, namely direct labor costs.

These costs usually remain constant throughout the year, although the amount of product produced can fluctuate. An employee's wages tend not to increase or decrease directly with the number of products produced.

What are Indirect Costs?

Indirect costs are costs that are not directly attributable to a particular product or service, but are related to the maintenance and operations of the company as a whole.

These costs are often also referred to as overhead costs. An example is expenses for materials and equipment needed in the company's daily operations, such as computers, electricity, and rental costs.

Although these items contribute to the company as a whole, they cannot be directly linked to the manufacture of a particular product or service.

Example of Indirect Cost

Some examples of indirect costs include expenses for office supplies, utilities, rent for office equipment, desktop computers, and cell phones. Like direct costs, indirect costs can be divided into fixed costs and variable costs.

Fixed indirect costs include expenses such as office rent which are fixed in a certain period. Meanwhile, variable indirect costs include fluctuating expenses such as electricity and gas costs which depend on usage.

Difference Between Direct Cost and Indirect Cost

In classifying payments as direct costs and indirect costs, you need to know the difference between the two, namely:

Direct cost

• Direct costs include expenses that are directly related to the process of creating a product or service. Some examples of direct costs include:
• Manufacturing supplies
• Equipment
• Raw materials
• labor costs and
• Other production costs.

All of these expenses are closely related to the production and development of a company's products or services.

Indirect Costs

On the other hand, indirect costs are expenses that are not directly related to a particular product or service. These costs are more general in nature and cover various aspects of a company's operations. Some examples of indirect costs are:

• utility
• Office supplies
• office Technology,
• marketing campaign,
• Accounting software
• Payroll.

All of these costs relate to running the company as a whole and are not directly attributable to any one specific product or service.

Knowing the different types of financing is very important to provide an in-depth understanding of products and more competitive pricing. Also, by monitoring direct and indirect costs, you will have a better understanding of business projections and future planning.