Direct and indirect costs

The important thing to differentiate when we talk about direct and indirect costs is the relationship they have with the object.

The fundamental difference between direct and indirect cost is that the first has a close relationship with the product or service while the indirect cost has a tangential relationship. Although it sometimes happens that the differences are not very clear and unforeseen expenses often escape, a calculation of direct and indirect costs is necessary to be able to apply them to the cost of a final product.

Direct cost
Indirect cost
  DefinitionThey are the costs that are directly related to the product or serviceThey are the costs that are tangentially related to the product
  • They are the sum of material, labor and equipment
  • Must be incorporated into the finished product
  • It must be proportional to the product
  • It is measured in percentage
  • It is difficult to measure, quantify and assign
  • It has a partial impact on the activities and an indirect impact on the cost of the finished product
  ExampleRaw materials or products that serve as the basis for the development of other projectsGas consumption of a company that then affects the product

What is a direct cost:

Direct costs or expenses are those that are directly related to the service or product that is offered. They must be established from the beginning and are obviously reflected in the budgets. This direct cost must also calculate what the labor costs per hour, that is, the salary of the personnel or hired for the task.

What does a direct expense include? Within a direct expense, all expenses related to the project must be included.

Direct cost example

Raw materials or materials can arise from nature or be produced by a company in the primary sector.

Direct cost characteristics

There are certain characteristics to consider for a cost to be straightforward:

  • It must be the sum of the costs of the material, labor and equipment used
  • Must be incorporated into the finished product
  • It must be proportional to the product
  • The degree of incidence should be expressed as a percentage

What is an indirect cost:

The costs or indirect costs relate tangentially to the projects or tasks to be performed. This cost affects the production of one or more products and must be taken into account when submitting a budget. It is a mistake not to take them into account because they affect the final cost of the product or service.

Indirect cost example

We can say, for example, that the electricity consumption of a company is an indirect cost. Renting the space is also an indirect cost.

Indirect cost characteristics

  • Although it participates in the process of the product, it is not physically incorporated into the finished product.
  • It is difficult to measure, assign and quantify.
  • It is linked to the productive period and the finished product.
  • It has an indirect impact on the cost of the finished product and a partial impact on the activities.

How to calculate direct and indirect cost

Many times it is not easy to calculate a direct or indirect cost or to differentiate to which category the costs of a project belong. We will leave some guidelines for it:

  • All lists that are needed to carry out the project must be prepared. Once the list is made, the costs that must be included for the management of the project begin to be defined.
  • Next, the approximate time it takes to complete the project must be calculated.
  • The costs that derive from the work both internal and external must be calculated, that is, the expenses within the company and the expenses of subcontractors or third parties.
  • Make a list of possible losses, for example raw material that expires or that for other reasons cannot be used or a machine that breaks.

Importance of management control and direct and indirect costs

A project manager must take into account to have foresight and prudence both in the daily management of the company and if you want to expand the market. You must also have a constant control of your company to optimize it.

It is important that any company, large or small, has a management control . This task is extremely effective when it comes to efficiency, effectiveness and profitability. It allows the control management to know the profitability of the business or company. You can evaluate if a product for example should not be produced, make changes in production, make different promotions of the product or distributions to achieve better sales.

It is important to be aware of the direct and indirect costs  that are generated in production and services for the proper functioning of the company. In this way, unnecessary costs and misuse of resources are avoided. What is sought with this is that there is a good economic profitability and that the company is successful.

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