What are direct costs?

Direct costs are expenses that can be directly tied to the production of specific goods or services. This category of costs includes materials, labor, and any other expenses that are incurred specifically for the manufacturing of a product or the delivery of a service. Such costs are essential for calculating the cost of goods sold (COGS) and understanding the profitability of a business at a granular level.

For instance, if a company produces furniture, the cost of wood, fabric, and the wages of the workers who assemble the furniture are considered direct costs. These expenses are variable and can change based on the volume of production, making them a critical component of financial analysis for businesses that manufacture goods.

In contrast, marketing and advertising costs, general overhead expenses, and customer service costs are categorized as indirect costs because they cannot be traced directly to the production of specific items. They contribute to the overall operation of the business but do not directly affect the cost associated with producing goods. Understanding the distinction between direct and indirect costs is crucial for effective financial management and decision-making in small businesses.