Indirect costs: examples and how to calculate them

Published Thursday 23 July 2026

Table of contents

• What are indirect costs?
• Indirect costs vs direct costs
• Examples of indirect costs
• Fixed vs variable indirect costs
• Why indirect costs matter
• How to calculate indirect costs
• How to allocate and reduce indirect costs
• Track your indirect costs with Xero
• FAQs on indirect costs

Key takeaways

• Indirect costs are the everyday running expenses that keep your business open, like rent, insurance, and utilities, even when you're not making a sale.
• Direct costs can be traced to a single product or service, while indirect costs support the whole business and need to be spread across it.
• Tracking indirect costs helps you set the right prices, protect your profit margins, and spot where you can trim spending.
• You can work out an indirect cost rate by choosing an allocation base, then apply that rate to price your work more accurately.

What are indirect costs?

Indirect costs are the general business and administration expenses that keep your business running, but aren't tied directly to making a product or delivering a service. They're the money you spend even when you're not selling anything.

Because they support the whole operation rather than one job, indirect costs are easy to overlook. They still add up quickly, so it pays to know what they are and how much they cost you.

Indirect costs vs direct costs

The simplest way to tell them apart is to ask whether a cost can be traced to a specific thing you make or sell. Direct costs can, indirect costs can't.

A direct cost is tied to producing a particular good or service, so it can be assigned to a single cost object. A cost object is anything you want to measure the cost of, such as a product, a project, or a customer. Raw materials and the wages of the people making the product are typical direct costs, and they usually sit within your cost of goods sold.

Indirect costs are the background running costs that support your business as a whole. You can't link them to one cost object, so you share them across everything you do. Rent, insurance, and admin salaries carry on whether you sell one unit or one thousand.

Examples of indirect costs

Indirect costs, often grouped together as your overhead, show up across almost every part of a business. Here are common examples you're likely to see:

• Wages for back-office and sales employees
• Office rent and supplies
• Insurance
• Utilities such as electricity, gas, and water
• Sales and marketing activities
• Merchant service fees for processing customer card payments
• Accounting and software subscriptions
• Depreciation of office equipment

Fixed vs variable indirect costs

Indirect costs don't all behave the same way from month to month. Some stay steady, while others rise and fall with how much you use them.

Fixed indirect costs stay much the same no matter how busy you are, so they're easier to plan around. Office rent and insurance premiums are good examples, since you pay the same amount whether business is quiet or booming.

Variable indirect costs change with your level of activity. Per-use data charges and some utilities move up when you're busier and down when you're not, so they're harder to predict.

Why indirect costs matter

Indirect costs can stay hidden because they're not attached to any single sale, so they slip out of view when you're focused on the work itself. Without a plan to price for them and fund them, they quietly eat into your profit.

These costs are climbing for many businesses. In its June 2026 Business Conditions and Sentiments survey, the Australian Bureau of Statistics found that 46% of Australian businesses reported higher operating expenses over the previous four weeks, and 65% of those pointed to rising business overheads as a main driver.

That's why indirect costs belong in your pricing. If your prices don't cover them, your gross profit can look healthy while your actual margins shrink. Building indirect costs into what you charge keeps your pricing honest and your business sustainable.

How to calculate indirect costs

To work out how much your indirect costs add to each job, you spread them across your business using an allocation base. Follow these steps to find a simple indirect cost rate:

1. Total your indirect costs for a set period, for example $60,000 a year in rent, insurance, utilities, and admin wages
2. Choose an allocation base that reflects how the costs are used, such as labour hours, machine hours, or floor space
3. Divide your total indirect costs by the base to get an indirect cost rate: $60,000 divided by 6,000 labour hours gives a rate of $10 an hour
4. Apply the rate to each job, so a project that takes 40 labour hours carries $400 in indirect costs

How to allocate and reduce indirect costs

Once you know your indirect cost rate, you can allocate those costs fairly and then look for ways to bring them down. Choosing an allocation base that matches how each cost is actually used, such as floor space for rent or labour hours for admin, keeps the split accurate across your cost of sales and overheads. Here are practical ways to reduce your indirect costs:

• Review your profit and loss statement to see where the money goes
• Renegotiate supplier contracts for rent, insurance, and utilities
• Automate routine admin so you spend less time and money on it
• Review your costs regularly rather than once a year

These same habits help when you're planning ahead, since keeping a close eye on overheads makes it easier to budget for start-up costs and future growth.

Track your indirect costs with Xero

Indirect costs are simplest to manage when they're all in one place and easy to see. Xero accounting software brings your rent, insurance, utilities, and admin spending together, so you always know where your money goes and can price your work with confidence. Get one month free on any Xero plan and take control of your costs today.

FAQs on indirect costs

Here are answers to some frequently asked questions about indirect costs to help you manage them with confidence.

What are the two types of indirect costs?

Indirect costs are usually split into fixed and variable. Fixed costs stay steady each month, while variable costs move up or down with how much you use them.

Are indirect costs tax deductible in Australia?

Many indirect costs that you incur running your business can generally be claimed as deductions, and the ATO and business.gov.au set out the rules that apply. Check your specific expenses against their guidance or speak with your accountant to confirm what you can claim.

What is the difference between indirect costs and overheads?

The terms are often used to mean the same thing, since overheads are the ongoing indirect costs of running your business. Some businesses use overhead specifically for premises-related costs like rent and utilities, while indirect costs cover a slightly wider set of expenses.

How do indirect costs affect pricing?

If your prices don't cover your share of indirect costs, your margins shrink even when sales look strong. Building an indirect cost rate into your pricing helps make sure every job contributes to your overheads.