Run a business – any business – and you likely will learn more than you’d ever want to know about operating costs. For the accountants and bookkeepers who watch these numbers, some terms become part of the everyday vernacular. Costs are broken down into direct versus indirect, with direct costs relating to those expenses that power the daily activities of a business. Indirect costs are those items that don’t directly connect to the products and services you provide but are no less necessary to keep the lights on.
Direct Cost: On-Site Laborers and Contractors
No work gets done without people. The employees and contractors who take your projects from “concept” to “completion” are direct costs. For employees, you’ll pay salaries and benefits, including health insurance. For contractors, you’ll pay hourly or per-project costs. You’ll need to track this throughout the year so that you can claim them as business expenses at tax time.
Indirect Cost: Head Office Staff
Some people are necessary to keep the business organized and running efficiently, but they do not get their hands dirty on the construction site. Examples include the tendering department, central procurement, the finance team, human resources and administrative staff. The salaries and benefits of these employees are indirect costs since they are not directly accountable to a construction project.
Direct Cost: Equipment and Supplies
No construction company operates without equipment. You’ll need cranes, concrete mixers, shovels and a wide variety of other supplies to scale to a successful business. These are all classified as direct costs and easily claimable as expenses on your yearly tax return. Even vehicles like bulldozers are direct costs. Often businesses question whether company vehicles are direct or indirect, but they can fall into the category of fringe benefits for employees, which are considered direct costs.
Indirect Cost: Shipping and Postage
For product-based businesses, shipping and postage can fall into a gray area. If you’re shipping products to customers, you may see it as a necessary part of doing business. However, construction companies usually have postage under the header of “administrative fees,” since you’re likely mailing invoices to clients and payments to vendors. The determining factor is whether any cost is directly related to the cost of providing services to your clients.
Indirect Cost: Utilities and Rent
The gray area ends when costs are supporting overall business operations. Expenses like the money you pay for your offices or to keep the lights are in support of general operations. As you look down the list of monthly expenses, question whether a cost supports everything you do, including back-office operations. If it does, it likely goes in the “indirect” category.
Indirect Cost: Support Staff and Contractors
In addition to the workers you have in the field, you also probably have a support team, even if it’s only one person. Those who handle your human resources, office management or administrative tasks are considered indirect costs. These are related to the overall business rather than the projects you work on each day. Even the salaries of the people crunching your numbers and determining which costs are direct versus indirect are indirect expenses.
Why It Matters
Budgeting matters in any business; it can mean the difference between profit and loss on the bottom line. When it's time to cut costs, it's important to be able to determine which expenses are more crucial for day-to-day operations and which ones can be cut down with minimal effect. By dividing costs into direct and indirect categories, you can judge which ones are least likely to hurt the business by cutting them, at least in the near future.