Direct and Indirect Expenses (2023)

Starting a business comes with a list of expenses, duties and situations that you would not have expected. But the first order of starting a business is to know how much money is going out of the business and how much money is coming in the business. Because at the end of the day the goal of any business is to make a profit. For this, you need to account for all the money that has gone out of the business, right from small expenses such as wages and electricity bills to large scale expenses such as rent and manufacturing units.

Before you get to the profit side of the business and how to do the accounting of the balance sheet and the profit and loss statement, you need to know the types of expenses in the business and how to account for them. In every business, two major types of expenses are classified: direct and indirect expenses. All expenses will either come under direct expenses or indirect expenses. You need to know which expenses come under what head as it makes a difference in accounting and can also help in deductions and tax-saving purposes.

It is important to ensure you track these expenses and enter them in the right head as it makes a difference. In this article, we will discuss all the different types of expenses a business may generally incur, how to segregate them, and the difference between direct expenses and indirect expenses. Read on to know more.

What are Expenses?

Whenever you start any business, you need to spend some money to get the business up and running. Once the business is up and running there will become recurring expenses that will have to be met on a daily basis, fortnightly, monthly or even yearly. While some expenses are recurring, there are some unexpected expenses that you haven’t accounted for or expenses that come up due to changes in business strategies and so on.

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The most basic types of expenses that every business will have to incur are:

  • Cost of raw material
  • Rent or land property to conduct the business
  • Electricity and water bills
  • Wages or salaries of employees

Post that, some expenses may occur once in a while or sometimes, based on different situations. These are unforeseen expenses that you should account for. Some of them are:

  • Cost of damaged goods because of events such as rains, fire, robbery
  • Legal expenses in case of legal situations
  • Discounts and sales
  • Staff overhead expenses

One needs to understand the expenses when they will be incurred and start accounting for them right from the start. They also need to have an emergency fund that can account for these unexpected expenses that may come up during the life of the business. These are the key points one needs to keep in mind in regards to the money that is going out of the business.

What are Direct Expenses?

Direct expenses are the core expenses of the business. Without these expenses, your business will not run. You need to account for these expenses no matter what the business situation is. These expenses are related to the raw material of the business or the purchase of the goods and services for the business. Direct expenses are expenses that go into producing goods or providing services.

Direct expenses are needed in every company, be it a manufacturing business, an e-commerce business, a service-related business. They are to be incurred. But the expenses that may be a direct expense for you may not be the same direct expense for another business.

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For example, there are two companies, one that manufacturers soaps and shampoos and another that is a re-seller of the same products. For the manufacturer of the soaps and shampoos, the raw material is his direct expense. However, for the re-seller, the raw materials are not a direct expense but instead, the expenses related to the product’s sales are a direct expense. In short, the expenses that are related to the main strategy or the core of your business are the direct expenses for you. Every company may have different direct expenses they are exposed to, but every company has direct expenses that need to be accounted for.

List of Direct Expenses

As mentioned above, the list of direct expenses may not be the same for every type of business and may differ from business to business such as manufacturing, selling, production, e-commerce. However, we’ve listed down a few of the generic direct expenses that a business may have to incur. This is not an exhaustive list and you should look more in-depth at the direct expenses your business may be exposed to.

Direct Expenses can be:

  • Factory, land or shop rent
  • Raw materials of the goods or the core cost of the business you’re in
  • Direct labour and wages for your business
  • Manufacturing supplies such as factory or machines

What are Indirect Expenses?

The expenses that a business needs to encounter for operation purposes are indirect. Just like how a business cannot function without indirect expenses, the same way a business cannot function without indirect expenses. While direct expenses cover the costs of the core materials for the business, indirect expenses are the overheads that need to be incurred for additional services for the business.

Indirect expenses may not be the same every month and will differ based on the revenue of the business and the nature of the business. While direct expenses are fixed, indirect is not fixed and may vary from time to time. Indirect expenses are not added to the cost of the final product or service but are accounted for separately, based on whenever they occur.

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Just as direct expenses are different for different natures of business, the same way, indirect expenses may be different for different businesses. For example, the indirect expense for a raw material company may be the wages and salaries of far off employees, but for a re-selling company, the wages and salaries may be direct expenses for them.

List of Indirect Expenses:

Indirect expenses are general business costs that need to be incurred to keep the business running. However, the general business cost may be different for all sorts of businesses. You need to identify what are the indirect expenses to the nature of your business. Also, not all indirect expenses will occur regularly and the same may vary or come up unexpectedly. All this needs to be accounted for while figuring the expenses of your business.

Indirect Expenses can be:

  • Utilities
  • General office supplies such as stationery, desk, chairs etc.
  • Overhead expenses such as Electricity bill, water bill
  • Pantry costs
  • Re-sellers wages and salaries
  • Unexpected expenses due to situations

Difference Between Direct and Indirect Expenses

Knowing the difference between direct and indirect expenses can help you in accounting and ensuring your expenses are earmarked carefully. Without the complete knowledge of direct and indirect expenses, you may account for costs differently which would hamper the books of accounts.

By a rule of thumb, the costs that are related to the core of your business should be accounted for direct expenses. These direct expenses would be different for all businesses but need to be incurred irrespectively.

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On the other hand, indirect expenses are costs related to operational running and need to be incurred for the smooth sailing of the business. Indirect expenses do not make a difference to the core of the business product or service but are mandatory for the overall business running services.

Direct ExpensesIndirect Expenses
Expenses related to the core of the business which is incurred during the raw material phase either for the product or the serviceExpenses that are incurred for the operation of the business, that ensure the smooth running of the overall business.
Direct expenses are included under the head of Cost of Goods Sold during accounting purposes.Indirect expenses are not included in the head of Cost of Goods Sold but may be included as Other Expenses or Overheads.
Direct Expenses are included in the trading account on the debit side.Indirect expenses are included in the income statement on the debit side.
Direct expenses are unavoidable and need to be incurred for the business to keep running and producing goods or services.While indirect expenses are unavoidable too, it is possible to reduce the indirect expenses or to combine a few indirect expenses to reduce the overall burden of the indirect expense cost.
Examples: Rent, Raw Materials, Cost of land, machinery, factoryExamples: Electricity and water bills, salary and wages of employees, utilities and overhead expenses

This is the categorization of direct and indirect expenses and one needs to ensure they know how the expenses are divided according to the nature of their business. A business should also prepare in advance a list of direct expenses and indirect expenses. Ensure you know this before diving right into your business model.

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FAQs

What are examples of direct and indirect expenses? ›

Some direct and indirect costs are tax-deductible. Examples of tax-deductible direct costs include repairs to your business equipment, such as your production line. Tax-deductible indirect costs may include rent payments, utilities and certain insurance costs.

What is indirect expenses Short answer? ›

Indirect expenses are those expenses that are incurred to operate a business as a whole or a segment of a business, and so cannot be directly associated with an object, such as a product, service, or customer.

How do you calculate direct and indirect expenses? ›

Direct Expenses are considered when the cost of goods sold is ascertained, whereas indirect expenses do not form part of the cost of goods sold. Direct Expenses usually appear on the debit side of the trading account. On the contrary, indirect expenses are shown on the debit side of the profit and loss account.

What are direct expenses also known as answer? ›

Direct expense is also known as direct cost.

What are examples of indirect expenses? ›

Examples of indirect expenses are accounting, auditing, and legal fees, as well as business permits, office expenses, rent, supervisor salaries, telephone expense, and utilities.

What are 5 indirect costs? ›

Examples of indirect costs are accounting and legal expenses, administrative salaries, office expenses, rent, security expenses, telephone expenses, and utilities.

What is the difference between direct and indirect cost? ›

Direct costs are expenses associated with production and sales. The cost of raw material and labor required to manufacture a product would be categorized as direct costs. Indirect costs are fixed expenses a business incurs to keep the company running no matter the activity level.

What is an example of a direct expense? ›

Direct costs are the expenses associated explicitly with a business' operations. For example, labor, materials and fuel are typically direct costs because they tangibly contribute to production.

What is the difference between direct and indirect material? ›

There are two types of materials; direct materials and indirect materials. Direct materials comprise raw materials that are directly processed into finished goods. In comparison, indirect materials are used in the manufacturing process but cannot be directly linked with a particular good.

How do you calculate indirect expenses? ›

In the budget, indirect costs are calculated by multiplying the sponsor's overhead rate by the direct cost base.

Is salary a direct or indirect expense? ›

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.

What are the examples of direct expenses? ›

Direct expenses means all expenses directly connected with the manufacture, purchase of goods, and bringing them to the point of sale. Direct expenses include carriage inwards, freight inwards, wages, factory lighting, coal, water and fuel, royalty on production, etc.

What are the 5 direct expenses on purchases? ›

Examples of direct expenses
  • raw materials.
  • sales commissions.
  • manufacturing supplies.
  • direct labor.
  • customer service.
  • purchase of goods to be sold.
  • transit of goods from the supplier.
Aug 27, 2018

What are the two types of expenses give examples of each? ›

Expenses can be categorized in a variety of ways. Expenses can be defined as fixed expenses, such as rent or mortgage; those that do not change with the change in production. Expenses can also be defined as variable expenses; those that change with the change in production.

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