Managing business costs require a clear knowledge of the major costs and how they fall into direct and indirect cost segments. This will help a business owner of any scale to control costs wherever possible and leverage benefits like tax savings, government grants, and other funding options.
Cost management is integral to achieving the efficiency, profitability, and success of a business. According to a study by PMI, only 53 percent of companies complete their projects within the original budget.
The yardstick of classifying payments as direct or indirect costs includes direct costs as something involved in creating, developing, and releasing a product. A better understanding of the nuances of competitive pricing will give a grip on accounting for future growth.
When the true costs in producing and providing goods or services to consumers are known, pricing products competitively and accurately will be much easier.
Direct costs explained
Direct costs, as mentioned, relates to expenses that a company incurs in making a product or executing a project. They include costs on software, servers, equipment, and raw materials.
Labor costs are also part of direct costs. In many companies, sales commissions also come under direct costs. Two methods for tracking these costs are “last-in, first-out (LIFO) or first-in, first-out (FIFO).” They show if the costs of materials have any fluctuations during production.
Most of the direct costs are variable but labor costs remain constant because wages do not increase or decrease in direct relation to the products made.
Indirect costs are expenses and costs involved in maintaining and running a company. This includes supplies needed for day-to-day operations. Since these items contribute to the company as a whole, they are not specific to any one service or product.
Examples of Indirect costs include supplies, utilities, office equipment rental, employee insurance, desktop computers, and cell phones.
Within the indirect costs, many are fixed and some others are variable. Fixed indirect costs include rent and variable costs include those of electricity and gas.
Good for leveraging tax benefits
Clarity on costs will help to claim tax deductions under better tax brackets. Some direct and indirect costs are tax-deductible. Examples of tax-deductible direct costs include repairs to business equipment including those on the production line. Tax-deductible indirect costs include rent payments, utilities, and certain insurance costs.
Rules about direct costs and indirect costs impact many funding schemes for small businesses. Government grants and other external funding plans have strict stipulations on what constitutes direct and indirect costs.
In norms related to government funds, the agency may have mandates on maximum indirect costs and expenses that can qualify as indirect costs.
There are many consulting agencies and consultants offering business cost-cutter services assisting companies to improve their bottom line. Their services include guiding businesses on savings programs that lower energy costs, healthcare costs, recovery of proper charges, information on class action lawsuits, tax incentive programs at state and federal levels among others.
There are also cost management tools that seek to bring about better cost management. Cost management software solutions are part of that.