Indirect costs

Published Thursday 23 July 2026

Table of contents

• What are indirect costs?
• Direct costs vs indirect costs
• Examples of indirect costs
• Fixed vs variable indirect costs
• How to calculate and allocate indirect costs
• Why indirect costs matter for pricing and profit
• How to reduce indirect costs
• Manage your business costs with Xero
• FAQs on indirect costs
• Related terms
• Learn more about indirect costs

Key takeaways

• Indirect costs keep your business running but can’t be traced to a single product, service, or job.
• They’re commonly called overhead, and they cover things like rent, utilities, insurance, and admin salaries.
• Indirect costs can be fixed or variable, so some stay steady each month while others shift with activity.
• Knowing your indirect costs helps you price accurately, protect your margins, and find savings.

What are indirect costs?

Indirect costs are the expenses that support your whole business rather than one specific product or service, so you can’t tie them to a single item you sell. They’re commonly called overhead, and they include costs like rent, utilities, and administrative salaries.

These costs still need to be paid to keep the lights on and the work flowing. Because they’re shared across everything you do, you spread them across your products or services rather than assigning them to one job.

Direct costs vs indirect costs

The difference comes down to traceability: direct costs can be traced to a specific product, service, or cost object, while indirect costs are shared overhead that can’t be tied to one item. If you can point to a cost and say which job it belongs to, it’s direct; if it supports the business as a whole, it’s indirect.

A quick way to keep the two straight is to look at what each cost pays for:

• Direct costs: raw materials, product components, and wages for staff working on a specific job
• Indirect costs: office rent, utilities, insurance, and salaries for admin or management staff

Examples of indirect costs

Indirect costs usually fall into two groups: the costs of operating your premises and the costs of running the administrative and sales side of your business. Here are common examples you might see in your books:

• Office rent and property costs
• Utilities such as electricity, heating, and water
• Business insurance
• Salaries for administrative and sales staff
• Marketing and advertising
• Office supplies
• Professional services such as legal and accounting fees
• Merchant and card processing fees
• Depreciation of shared equipment

Fixed vs variable indirect costs

Indirect costs aren’t all the same: some stay steady no matter how busy you are, while others rise and fall with your activity. Sorting them this way helps you predict what you’ll spend as your business grows or slows.

Steady expenses like rent and insurance premiums are usually fixed costs, since they don’t change month to month. Expenses like utilities, shipping supplies, and card processing fees are often variable costs, because they move with how much you produce or sell.

How to calculate and allocate indirect costs

To calculate your indirect costs, add up every overhead expense for a set period. To allocate them, you spread that total across your products, services, or departments using an allocation base, which is a shared measure that reflects how each area uses those resources.

Common allocation bases include labour hours, machine hours, and floor space. You pick the base that best matches what drives your overhead, then divide your total indirect costs by that base to get a rate.

Here’s a simple worked example. Say your total indirect costs for the month are $10,000 and your equipment runs for 500 machine hours. Dividing $10,000 by 500 machine hours gives you $20 per machine hour, so a job that uses 10 machine hours absorbs $200 of overhead.

Why indirect costs matter for pricing and profit

Indirect costs shape both your prices and your profit, even though they’re easy to overlook. If you set prices using only your direct costs, your overhead eats into your margin and can leave you selling at a loss without realizing it.

Building a fair share of overhead into each price helps you cover your true costs and protect profitability. Tracking these costs also shows you where your money goes, so you can make confident decisions about what to charge and where to trim.

How to reduce indirect costs

Trimming overhead is one of the quickest ways to improve your bottom line without raising prices. A few practical habits can keep these costs in check throughout the year.

• Review your overhead regularly to spot expenses you no longer need
• Negotiate rates with suppliers, insurers, and service providers
• Cut waste such as unused subscriptions and excess energy use
• Use automation and accounting software to reduce manual admin time

For more ideas, see the guide on how to cut business costs.

Manage your business costs with Xero

Keeping a clear view of your indirect costs is much easier when your expenses are tracked in one place. Xero brings your bills, spending, and reports together, so you can see where your overhead goes and where you can save.

With real-time reporting, you can monitor costs as they happen and make confident pricing decisions, so you spend less time on the books. Get one month free when you sign up to Xero.

FAQs on indirect costs

Here are answers to some frequently asked questions about indirect costs to help you apply them in your own business.

Are indirect costs the same as overhead?

Yes, overhead is another name for indirect costs. Both terms describe the shared expenses that keep your business running but can’t be traced to one product or service.

Are indirect costs fixed or variable?

They can be either. Rent and insurance tend to stay fixed, while costs like utilities and card processing fees usually vary with your activity.

How do indirect costs affect pricing?

You need to recover a share of your overhead in every sale. Leaving indirect costs out of your prices can quietly shrink your margins.

Is depreciation an indirect cost?

Depreciation on shared equipment or premises is usually an indirect cost. Depreciation on an asset used for a single product or job can be treated as a direct cost instead.

Can a cost be both direct and indirect?

Yes, the same type of cost can be either depending on how it’s used. Electricity to run one machine on a specific job is direct, while electricity to light your office is indirect.

Related terms

• Direct cost
• Overhead
• Operating expense
• Fixed cost
• Variable cost
• Expenses

Learn more about indirect costs

• Managing overhead costs
• Business cost-saving ideas
• Pricing strategies and COGS
• Increase profits